Things from my Google Reader: Sep-12 Edition

With summer ending, and Autumn beginning, here’s some things that Our Man read over the last couple of months.  As per normal, the articles become more serious the further you manage to get through this post!  With that in mind, why not start off with some Sports News!

Sports News 
- The London Chronicles: Great Britain Lives Up to its Name! 
The Olympics were held in Our Man’s home town this year, and after a slow start Team GB exploded into life on "Super Saturday".  Even American uber-sports writer Bill Simmons was impressed. (Bill Simmons, Grantland)

- RA Dickey Has Straightened-out His Life and Crooked-out His Pitches 
The most interesting man in baseball, and one of the (very few) bright spots on a very mediocre (and apologies to the word mediocre, for the insult!) Mets team!  Bizarrely, it’s not hyperbole to ask if the only man in the world currently capable of throwing a knuckleball at a Major League-level is about to be declared the best pitcher in the National League this season!  (Dave Sheinim, Washington Post)

- Cosell Talks: Eli’s Arrived 
Finally, with Football season kicking off, what better time to reminisce in the happy ending to last year’s season and Super Bowl  XVLI.  (Greg Cosell, NFL Films)  

And In the Real World 
- How Apple & Amazon Security Flaws Led to my Epic Hacking 
If (for some unbeknownst reason) you don’t have a two-step verification process for your email, then this article will inspire you to get one…quickly!  A look at how simple it is for someone to take over your online life and all of your accounts, while knowing minimal data about you.  It also says rather a lot about the poor controls at Amazon & Apple (amongst others), and how little they value your data.  The author, who’s technologically far more savvy than Our Man, did manage to get his digital life back!  (Matt Honan, Wired)

- A Critic's Manifesto: The Intersection of Expertise & Taste
A critic's view of what a critic should do, or least aim to do. (Daniel Medelsohn, The New Yorker) 

- The Weasel, Twelve Monkeys And The Shrub
Since it's election season, and Our Man doesn't talk politics, here's some political reading for those of you that need your election fix.  A David Foster Wallace's article from his time on John McCain's campaign bus, back in 2000!  A more interesting and far better read, than anything you're likely to see that's a little more 2012-relevant!  (David Foster Wallace, Rolling Stone...though since I couldn't find a copy on their website, this one is from Txt Post)

- The NSA is Building the Country’s Biggest Spy Center 
Now Our Man and Mrs. OM are fans of the CBS show “Person of Interest”, which is based around a government program that tracks all of our communications, which a former CIA agent & a computer genius-type guy use the information from to try and help prevent crimes.  Who knew that it’s all rather closer to the reality than fiction!  (James Bamford, Wired) 

- China: Shadow Bankers Vanishing Leave China Victims seeing Scams 
Yup, China, again!  Our Man may seem like Chicken Little, but it is stories like this, and their ever increasing prevalence, that should be worrying to folks!   Credit is (unfortunately) the key building block of modern-day economies, and there ever increasing signs that the underlying collateral is either over-valued or doesn’t exist (i.e. Ponzi finance)!  You saw what happened in the US, when supposedly good collateral (housing) was significantly over-valued…now imagine vast reams of it not existing!  (Bloomberg News)

- Roberts Switched Views to Uphold Healthcare Law 
I don’t much care if you think the Healthcare Law is good, bad or indifferent, I just thought this was the best reporting of the Supreme Court’s decision and what went on behind the scenes.  Given the paucity of actual reporting (as opposed to opinion masquerading as such) in the press these days, it’s worth acknowledging.  (Jan Crawford, CBS News)

August 2012 Review

Portfolio Update
- As noted in the recent “After Half-Term Ponderings” it seems that we’re set for QE Everywhere.  With the portfolio positioned poorly for this, Our Man added a position in Gold (GLD) for a 6-12month ‘trade’.

Performance Review
Despite August proving a positive month for the markets, the portfolio fell by 64bps during the month once again leaving the portfolio around flat (+0.15% YTD) for the year.

The fund spent the entire month in the red with the losses being fairly broadly spread across the portfolio.  The Puts/Hedges (-21bps) and China Thesis (-11bps) books both suffered as markets across the globe rallied, with both now representing very limited exposure.  The Currencies book (-29bps) gave back most of July’s gains, with almost the entirety of the loss coming after ECB President Mario Draghi pledged to do everything to support the bond markets (especially those in Spain/Italy) and keep the Euro together.  The Treasuries book (-7bps) also gave back part of its recent gains.  Finally, despite the general rise in equities, the Value Equity book (-32bps) was also a negative contributor.  This was due to the fall in THRX, which saw some profit-taking following its 25%+ rally during July, and despite a positive contribution from DRWI.

The positive contributions were all relatively small.  The Absolute Return/Bond Funds (+13bps), NCAV (+5bps) and Energy Efficiency (+8bps) books both benefited from the rise in risk appetite and asset markets.  The addition of the GLD position, meant that the Precious Metals book (+10bps) proved to be well-timed with expectations for QE3 rising after Fed Chairman Ben Bernanke’s speech at Jackson Hole

Portfolio (as at 8/31 - all delta and leverage adjusted, as appropriate)
19.1% - Bond/Absolute Return Funds (DLTNX and HSTRX)
7.3% - Precious Metals (GLD)
6.8% - Value Idea Equities (THRX, and DRWI)
5.2% - Treasury Bonds (TLT)
2.5% - Energy Efficiency (AXPW, and XIDE)
0.6% - NCAV Equities
0.0% - Other Equities (none)

-1.0% - China-Related Thesis (34bps premium in EWZ Jan-13 puts)
-0.1% - Hedges/Put Options (8bps in IWM Jan-13 puts, 7bps in SPY Jan-13 puts and 4bps XLY Jan-13 puts)

-12.4% - Currencies (EUO – Short Euro)

51.8% - Cash

Disclaimer:  For added clarity, Our Man is invested in all of the securities mentioned (TLT, DLTNX, HSTRX, GLD, THRX, DRWI, AXPW, XIDE, , EWZ puts, IWM puts, SPY puts, XLY puts, and EUO).  He also holds some cash.  You should not buy any of these securities because Our Man has mentioned them, but should do your own work and decide what’s best for you.

After Half-Term Ponderings

After a flat first half, there’s not a vast amount to analyze with regards to the portfolio’s performance.  As such, this year’s half-term ponderings will focus on some (half-formed?) thoughts that have been germinating in my mind. 

- More QE – everywhere?

While the summer has largely been very quiet, the one thing that stands out is the increased likelihood of more quantitative easing or stimulus across the globe.  We’ve had the continual hints of QE3 from various Fed doves, and the market remembers Bernanke’s 2010 words at Jackson Hole that signaled QE2 while it waits for him to speak at the same venue on Friday (my guess is he’ll talk the market up, but we won’t see QE3 enacted till December’s Fed meeting).  More surprising was ECB President Mario Draghi’s July promise to “do whatever it takes” and claims that this action “will be enough”.  This being Europe, it goes without saying that “whatever it takes” depends on what country you’re from and the political dance matters as much as the promises; we wait to see what the reality of Draghi’s promise is and whether it’s enough.  Finally, there’s China where the data continues to come in weak, which has led to hopes of another 2009-style round of investment spending and stimulus.

Frankly, the fact we’re now discussing yet another round of QE should be sign to the Fed that they’re pushing on a string and that the previous rounds have failed at stimulating any sustainable growth.  However, I’m sure they feel the need to do something and the world of the counter-factual (“imagine how much worse it would be without QE1/2/Operation Twist/etc”) that they inhabit no doubt provides reason enough to try more unorthodox policy in the hope something works.   It’s no surprise that I’m skeptical about there being any medium-term benefits (despite the long-term costs).  However, with global QE/stimulus seemingly coming and the portfolio not particularly well positioned for it, Our Man’s added a little Gold as a 6-12month ‘trade’. 

- Has the Fed succeeded, at least on one psychological level, by turning everything into a yield asset?

While there’s much debate over the whether QE1/2/Lite, Operation Twist, et al have succeeded in generating any sustainable economic growth, they have succeeded in getting investors to focus on yields.  This is evident across markets, from the obvious places such performance of Investment Grade bonds (LQD: +9% YTD) and High Yield (JNK: +7.5%) to the keen focus on dividend yield stocks and on potential rental yields in the housing market.  By persuading investors to reach for yield, and kindling their animal spirits the Fed’s moves can be seen, so far, as a success by helping to drive a range of asset prices higher and endowing people with the wealth effect.

The problem, of course, is that by encouraging investors to “reach for yield” the Fed is also trying to persuade them to focus on return on capital rather than return of capital, and thus take more risk.  What do I mean by this?  Let’s take the simple examples: much has been written about how “cheap” stocks are, either due to their earnings yield (inverse of P/E) or their dividend yield.  As these yields compare very favourably to the low yield on a 10-year Treasury, the argument goes that one should own stocks.  After all, a 10-year Treasury yields a mere 1.6%, why wouldn’t you want to own the S&P 500, which has a 2.1% Dividend Yield, instead.  The answer of course lies in the risk you’re taking to earn those yields, or more simply – bond math matters.  In bond-world, a major risk metric is duration which simply tells you the weighted average of the time that the cash-flows from an asset are received.  For a 10-year Treasury bond this figure is between 7-8years, for the S&P based on the dividend yield it is 30-40years, hence in the world of bond-math you’re taking 4-5x the risk to own the S&P.  Suddenly, that extra 50bps/year of extra yield doesn’t quite look as attractive… 

- Earnings: But what about the margins?

Our Man has long been surprised at the resilience of corporate profit margins, which have hovered around historic highs for the l2mos and whose strong bounce-back from 2008/9 has driven Earnings-growth and been an important contributor to the rally in stocks.  Interestingly, we’re now starting to see Earnings-growth falter for the first time post-2008, with YOY Earnings growth turning negative in Q2-2012. 

This fall has also started to impact analyst projections for the upcoming quarters, which have steadily fallen throughout the year. 

Given the falling Earnings, and with margins at historic highs, it means that the market is relying on either multiple expansion or the quick reversion of this trend to help it go higher.  That should sound a note of caution to investors.

- Ideas: what’s Our Man looking at?

As is traditional a little note/insight, albeit brief this time, into some of the new things that Our Man is pondering and spending his free time looking at.

a). Europe:  There are signs, like this Global Shiller/CAPE analysis by Mebane Faber, that Europe is approaching the boundary being potentially very cheap.  While a number of European countries certainly look cheap comparative to other OECD nations, Our Man is keen on looking at them versus their own history before declaring them absolutely cheap and looking to invest.  Given Our Man is limited to US-listed positions, any future positions will largely be ETFs or potentially some ADRs.

b). Possible Puts/Shorts:  Generally, Our Man can only short using puts and predominantly has to use ETFs to get his exposure.  That said, I’m looking at few things that might be interesting.  The fall into two main buckets; (i) Stocks which have benefited as investors chased yield and may offer opportunity if the dividend isn’t as secure as it seems on the surface (areas of interest include REITs and some Consumer Staples/Telecoms), (ii) stocks where the drivers of growth are misunderstood or where the forward-looking expectations are particularly unrealistic (the two names, in particular, that have drawn Our Man’s interest are Lulu Lemon and Tesla, although Apple is, or rather one-day could be, potentially particularly fascinating)

July 2012 Review

Portfolio Update
- There were no changes to the portfolio during the course of July.

Performance Review
July was a decent month for the portfolio, which rose 80bps putting the YTD performance back into the positive (+0.8%) though this pales in comparison to equity indices globally (S&P 500 TR: +11.0%, MSCI World +7.7%).

Continued concerns about the macro conditions in the US helped the Treasury Bond (+19bps) and Bond/Absolute Return (+15bps) buckets perform solidly.  This was compounded by the continued struggles of Mediterranean Europe, which saw the Currencies book (+34bps) add to performance as the Euro weakened.  This uncertainty was met with increased belief that monetary authorities across the world (especially Europe, US and China) were willing to engage in further QE (or fiscal stimulus in China’s case) and the resultant rally saw the aforementioned books give back much of their gains before month-end, and also hurt the China-related (-15bps) and Puts/Hedges (-9bps) positions.

The performance of the Equity-related books was quite mixed.  In the Value Equity book (+69bps), Dragonwave (DRWI) continued to negatively impact performance; while the company completed its business transforming acquisition of Nokia Siemens Network’s Microwave Trasportation business, the short-term prospects continue to reflect difficulties with the company issuing revenue guidance beneath analysts estimates for next quarter.  This negative performance was offset by another strong month from Theravance (THRX) – the company’s results were in-line with expectations, and the progress of their key drugs continues to be positive.   The Energy Efficiency book (-32bps) was a negative contributor, as analysts worried about the strength of XIDE’s earnings given the weakness in Europe and their sizeable business there.  The NCAV book (-2bps) is a solitary position at this time, and had limited impact on the portfolio.

Portfolio (as at 7/31 - all delta and leverage adjusted, as appropriate)
18.9% - Bond/Absolute Return Funds (DLTNX and HSTRX)
7.1% - Value Idea Equities (THRX, and DRWI)
5.2% - Treasury Bonds (TLT)
2.4% - Energy Efficiency (AXPW, and XIDE)
0.5% - NCAV Equities
0.0% - Other Equities (none)

-2.1% - China-Related Thesis (44bps premium in EWZ Jan-13 puts)
-0.4% - Hedges/Put Options (16bps in IWM Jan-13 puts, 12bps in SPY Jan-13 puts and 11bps XLY Jan-13 puts)

-12.9% - Currencies (EUO – Short Euro)

58.6% - Cash

Disclaimer:  For added clarity, Our Man is invested in all of the securities mentioned (TLT, DLTNX, HSTRX, THRX, DRWI, AXPW, XIDE, , EWZ puts, IWM puts, SPY puts, XLY puts, and EUO).  He also holds some cash.  You should not buy any of these securities because Our Man has mentioned them, but should do your own work and decide what’s best for you.

June 2012 Review

Portfolio Update
- June saw the second (much smaller) tranche of the redemption discussed in April, with Our Man again deciding to reduce the cash position slightly and concentrate the exposure into the existing portfolio.

Performance Review
The markets bobbed around without any clear and consistent trend for the vast majority of the month before rallying strongly in the final days, after the latest European summit seemed to suggest another plan to ‘fix’ things.  The month was a different one for the portfolio, which various elements moving in different directions as some idiosyncratic company-related events largely made up for the broad under-performance of the more macro-related elements.  The end result however was rather flat performance (+0.07% in June), which pretty much summed up the first-half of the year (-0.01% YTD)

Unsurprisingly, given the sharp rally in the market and the late-in-the-month positive sentiment towards Europe the Puts/Hedges (-56bps), and the Currencies (-32bps) books were the main negative contributors.  The China Thesis (-39bps) also hurt performance, with hopes of a soft landing in China and the potential for recovery in Europe (China’s largest export market) working against the book.

Against this, the equity-centric books were the positive driver’s of performance.  The Value Equities (+61bps) book was aided by the constructive market environment, with THRX benefiting from the positive sentiment in the biotech/healthcare space which saw a number of transactions, including GlaxoSmithKline’s completion of its acquisition of 10mn shares in THRX that was announced in April.  The Energy Efficiency book (+77bps) was the largest contributor to the portfolio.  The book was driven by the performance in XIDE, which announced reasonable numbers.  The company has a checkered history with constant Given the company’s terrible history of restructuring and constant charges the company rightly trades at a discount to peers; however, the hints that the current management are reaching the end of their restructuring after bringing the company out of bankruptcy could have a substantial impact on the firm’s Earnings, ability to capture some of the market (in micro-hybrids) that’s becoming available to them, and their rating.  We shall see, over the next couple of years, if it’s another false dawn in Exide’s emergence.

Elsewhere the Treasuries (-8bps), Bond Funds (+4bps) and NCAV (+1bp) books had a very limited impact on performance.

Portfolio (as at 6/30 - all delta and leverage adjusted, as appropriate)
18.9% - Bond/Absolute Return Funds (DLTNX and HSTRX)
6.5% - Value Idea Equities (THRX, and DRWI)
5.1% - Treasury Bonds (TLT)
2.8% - Energy Efficiency (AXPW, and XIDE)
0.5% - NCAV Equities
0.0% - Other Equities (none)

-1.9% - China-Related Thesis (60bps premium in EWZ Jan-13 puts)
-0.5% - Hedges/Put Options (19bps in IWM Jan-13 puts, 17bps in SPY Jan-13 puts and 12bps XLY Jan-13 puts)

-12.4% - Currencies (EUO – Short Euro)

59.0% - Cash 

Disclaimer:  For added clarity, Our Man is invested in all of the securities mentioned (TLT, DLTNX, HSTRX, THRX, DRWI, AXPW, XIDE, , EWZ puts, IWM puts, SPY puts, XLY puts, and EUO).  He also holds some cash.  You should not buy any of these securities because Our Man has mentioned them, but should do your own work and decide what’s best for you.

It's Okay to Not Know...

“[T]here are known knowns; there are things we know that we know.

There are known unknowns; that is to say there are things that, we now know we don't know.

But there are also unknown unknowns – there are things we do not know, we don't know. ”

— US Secretary of Defense, Donald Rumsfeld

While I was never much of a fan of Secretary Rumsfeld, it always struck me as peculiar the people took such issue with this statement as it seems a fairly logical distillation of a rather complex thing.  Given that a number of Our Man's friends, acquaintances and contacts are in the financial world, it's even stranger that folks criticized the statement as it would seem to me that unknown unknowns could just as easily be called Black Swans.  Though, I suppose it was made in a pre-2008 world when black swans weren't as popular a topic.

So, why bring up Secretary Rumsfeld’s quote now?  Well, despite what you might hear if you have the misfortune to tune into CNBC, it’s okay to not know or have any conviction in a particular outcome.  It is however, important that you realize that you have limited conviction and behave accordingly.  We’re taught that if we do the “work” – if we research, think about and analyze a problem – we’ll find the answer (i.e. reach a conclusion in which we have conviction).  It’s those known unknowns and the pesky Black Swans (unknown unknowns) that mean this isn’t the case in reality.

I bring this up because Our Man’s portfolio continues to run relatively low exposure and the performance is where it has been all year, roughly flat.  The low exposure is a reflection of my lack of conviction; that I don’t know.  On the Equity-side, this is easy to explain – while the current positions have sufficient assets or earnings to make them ‘cheap’, most of the driver of future returns is based upon some form of change or future growth.  While I believe that you’re paying little to nothing for this growth and/or I’m more positive on the probability of its occurrence, potential size, and proximity, it’s also very likely given their uncertain nature that these factors will be influenced by the macro environment.  Thus, the positions are undersized to reflect my well-known macro skepticism.  What will cause the equity book to grow?  Well, a change in the macro conditions, a change in the risk/reward in existing names, or adding new names or a theme to the book; expect to hear more on these topics soon.

So, if I’m bearish, why are the Puts/Hedges and China thesis portfolios so small?  Well, for the following reasons: we’re not there yet and the Fed (and other Central Banks).  While my bearishness is unchanged and the economy remains relatively weak (and I think noticeably weaker than people realize) it isn’t yet absolutely weak.  As discussed before, my two favourite indicators for getting a sense of where the economy stands today are the Philly Fed’s Aruoba-Diebold-Scotti Business Conditions Index and the Chicago Fed National Activity Index. 

The second reason is the Fed who have shown a belief that throwing liquidity at problems will solve them, despite the lack of evidence that it does any more than provide a temporary sugar high while potentially creating greater distortions in the markets.  However, their willingness to do so seemingly every year (surely a sign of its outstanding success) means that there is a higher bar required (i.e. the economy must be weaker than historically) or signs of greater exogenous weakness (China and Europe) before I’m willing to increase the size.  

In short, my current level of conviction is relatively low ("I don't know") and thus the portfolio's level of exposure is low. So I'm spending my time doing two things (i) waiting for the data to change and help me build some short-medium term conviction in the existing theses, and (ii) looking into, researching, thinking about and analyzing some new ones.  When I've either built greater conviction in the existing theses or am close to putting new ones into the book, then this blog will become more lively and the portfolio's exposure and risk will start to increase.

Things from my Google Reader: Jun-12 Edition

Apparently, it has been almost 9 months since Our Man updated you with articles of interest that he’s been reading.  Thankfully, this isn’t a reflection of a drop in the quality of his reading material but instead solely represents at how poor he’s been posting it to this blog – apparently, putting the information together in a word document and expecting it to post itself, doesn’t work so well.  Thus, there is much catching up to do…so expect a plethora of “Things from my Google Reader” posts this summer.  This one will follow the typical format, with the most financial-orientated links at the bottom!

- A Nice Cup of Tea 

As you know, Our Man is a Brit and there’s nothing Brits like more than a cup of char (in fact, I’m having one now…as I write this).  I also have to say that American tea-making standards are pretty low (Mrs. OM is a fan of putting the milk in first, perish the thought!).  So, in this stressful world (and especially for my American friends) let George Orwell’s 1946 article school you on this important matter.  (George Orwell, Evening Standard)

- “Keep Calm and Carry On” (Video) 

I’m sure you’ve all seen the slogan on t-shirts and posters, but have you ever wondered where it came from?   This short film tells you the story behind the poster; from its origins at the start of the second World War, to how it was rediscovered in an English bookshop in 2000 and introduced into the public consciousness.

- Coaching a Surgeon:  What makes top performers better?

Given that top class athletes and singers have coaches, so why don’t you have one for whatever you do?  Irrespective of your training for your job, can you perform at your best on your own?  Clearly, some occupations lend themselves to this concept better than others but it’s a fascinating concept and well worth you reading about one surgeon’s experiences and research.  (Atul Gawande, New Yorker)

All things China

As y’all know, Our Man has been somewhat skeptical on China for a long-time.  While this was originally a contrarian view, the debate over China has progressed from whether China will (ever) slow-down to whether there will be a soft or hard landing and what’s a reasonable rate of growth to expect from China going forwards.  Here are some interesting articles that illustrate the change in tone over China, from the last few months:

- Professor Michael Pettis and the Economist’s Free Exchange blog have a two-legged wager on whether China will overtake the US within a decade and what Chinese GDP growth will be. (Michael Pettis’ blog & The Economist)

- Jonathan Weil finds that Chinese big banks look more like paper tigers, in large part to the remnants of the last time the government had to bail them out (something Our Man has discussed before). (Jonathan Weil, Bloomberg)

- Arthur Kroeber wonders if it will be social discontent and income inequality that will lead to China having issues (Arthur Kroeber, Foreign Policy)

- John Hempton is the most skeptical of all, suggesting China’s a “kleptocracy of a scale never seen before in human history” and tries to explain how it’s financed, and what might make it fail.  (John Hempton, Bronte Capital)

Financial Regulation – Some Andy Haldane love!

Financial regulators have done little good over recent decades, in large part because they’ve failed to understand Finance.   One of the few exceptions is Andy Haldane, the FSA’s Executive Director for Financial Stability, who Justin Fox (at HarvardBusiness Review) dubbed “the regulator who explained the world”. 

Personally, I was more impressed by the way the way he applied work from other fields and considered their impacts on finance.  Some of my favourite Haldane articles/speeches:

- “Patience & Finance”, where he looks at the role of patience in decision-making and the impact of patience, or rather succumbing to impatience has had, on finance.  (Oxford China Business Forum, in Beijing) 

- “The Short Long”, on whether the world (and stock market in particular) is becoming more short-sighted and myopic.

- “The Doom Loop”, where he talks about equity and the banking system. (Andy Haldane, London Review of Books)