OCTOBER MONTH END SUMMARY AND LOOKING AHEAD TO NOVEMBER
Portfolio October Performance: -9.03% S&P 500 October Performance: -1.98%
Portfolio YTD Performance: +33.53% S&P 500 YTD Performance: +12.29%
Portfolio Highlights For October:
- SPRT was sold for a gain of 40% since initiating the position on August 7th. This was the third successful, double digit percentage profit taken in the stock since the original research report was published on January 29th, 2012. The position was liquidated during the first week of October, as a result of my growing skepticism regarding the market in general. Subsequently, my posture became more defensive as opposed to offensive as the month progressed.
- The portfolios were hedged via TZA (3x inverse small-cap ETF) on October 10th. This hedge, along with liquidations of numerous holdings, put the portfolios in a net neutral position early in the month. A defensive posture is warranted given both portfolios performance this month, along with some worrying technical deterioration in numerous important market indicators and indices.
- The portfolios started October with 100% long exposure. As of today, that exposure has been scaled back to 45% long, 15% short (45% notional), 40% cash.
Portfolio Lowlights For October:
- ATNY was liquidated earlier in the month for a loss at an average price of 2.80. The restructuring that has been ongoing at the company seems to have run over in terms of time and damage to the quarterly top and bottom lines. Worries over budgetary concerns within Congress with respect to defense spending also seem to be inhibiting investor participation. Recently, the company did announce that they are exploring strategic alternatives (a sale), hiring a respectable investment bank to assist with the process. I have always thought this was an inevitable outcome. However, I didn't think that the company would sink more than 25% from where I originally purchased it, only to be bought out at a 75% premium. I prefer to have my timing with respect to investments like this a bit more refined. Unfortunately, in this case, that wasn't to be.
- PXLW, a company initiated in early August that proved to be quite profitable right off that bat, gave back all of its gains and then some throughout October. The primary catalyst behind the losses in October was an average earnings report and below average guidance. The guidance the company gave fit right in with what a majority of corporate America saw during Q3. That was a dramatic softening during the second half of the quarter. It seems to have intimidated PXLW management enough to the point that they guided down Q4 substantially, causing a 20% decline in the stock to take place on the day after earnings were released. PXLW has always had a history of volatility in earnings. I believe that the company is trading at the bottom end of its historical price range. Barring the second coming of an economic catastrophe, the company should find a good deal of support at current price levels. Fortunately, half of the PXLW position was liquidated as a part of a mandatory portfolio stop earlier in the month, before the negative earnings report was released. Nevertheless, the position was a contributing factor to poor performance during the month.
- UPIP, initiated in late-September, experienced an adverse court ruling with respect to a preliminary "Markman" order. This is an initial defeat for the company in their patent lawsuit against Apple and Google. However, it is literally the first inning of the battle and this was only an initial blow to their case. There will be further rulings, the most important of which will be out of Nevada, the companies new corporate headquarters. I am expecting that the patents will hold up much better than the Markman has indicated. Nevertheless, half of the position was liquidated as a part of a mandatory portfolio stop earlier in the month, which mitigated some of the damage.
- SPNS continued its tendency towards being ignored despite an improving overall fundamental situation. There is an extremely frustrating liquidity issue with the company. It took me quite awhile to liquidate a modest sized position in the stock to cut the holding in half. I continue to hold a small position in the company. This has been the most trying position of all given the fundamental improvements with a complete lack of recognition by the market. The steady leak continued with SPNS finishing the month down 5%.
- WMIH I made a small addition to during the month. Given the fact that WMIH is essentially a shell company trading near net cash value, there is very little correlation to the overall market. A weakening market shouldn't influence the stock in a negative manner. The company was, nevertheless, down 4% for the month. It is currently the largest position in the portfolios.
- A mandatory 5% portfolio stop was hit during the month, causing a liquidation of 50% of net long exposure to take place. Despite this liquidation occurring during the first half of the month, the portfolios continued to leak equity until the very last day of the month. A confluence of company specific bad news, with respect to PXLW and UPIP, along with a small-cap sector that doesn't see much in the way of sizable bids, led to a steady drift downward during the month. Positions will be liquidated further as warranted, going up to as high as 90% cash if performance continues to suffer.
Looking Ahead
The last paragraph of the September Monthly Summary said, "As bullish as I am over the longer-term, I believe that October may be a point to turn cautious until we see how the market wants to resolve these important levels." We can now see clearly that caution was indeed warranted. The question becomes, does a cautious stance continue to be the most prudent course of action?
The answer is a resounding yes for a number of reasons. The first reason being that there is a strong possibility that the markets are entering an intermediate term period of sideways volatility. Sideways volatility tends to wreak havoc on small-cap names as the phenomenon of "leaking equity" that the portfolios experienced in October becomes par for the course. My trend indicators seem to agree, as they all continue to deteriorate, with the short-term indicator turning bearish earlier in October.
I outlined recently the three reasons I believe the markets will go nowhere in November:
1. Bottom pickers: If picking bottoms only leads to smelly fingers, then all of Wall Street must stink, at present. There are far too many individual and institutional investors who have become perfectly content with not looking at the potential for downside, but rather focusing on when a bounce will occur and how large its potential. This type of mindset becomes problematic especially when the markets have suffered significant technical damage in important indices such as the COMPQ, NDX and SOX. In 18 years, I have not seen a single bottom of significance take place when a majority of the focus is on capitalizing on the bounce rather than protecting from further downside. Invariably, this mindset absolutely needs to reverse before the bottom everyone seems to be waiting for can take place.
2. Technical damage: There is far too much of it across major market averages. I have outlined how we were in the process of failing at important generational trajectory points over the past few weeks. The type of technical damage we have experienced resolves in one of two ways:
A. Panic to the downside resulting in high volume rinse. Capitulation, in other words.
B. A prolonged sideways range that slowly causes the entrenched bulls to give up their optimism.
I happen to think we will see a resolution with B over the next few months, rather than A.
3. Earnings shock: The earnings that have been reported during Q3, along with Q4 guidance are not going to support a prolonged rally until some of the variables start becoming less murky. Based on the caution expressed in nearly every conference call as of late, you can expect that October was a weak start to Q4. November will likely be just as weak until the uncertainty of what the elections mean for the United States and the world start becoming more apparent. It will likely be December before investors can accurately gauge whether the markets have become “investable” again based on available data. This sets the markets up for a best case scenario of choppy conditions in November.
It goes without saying that if the best case one can make for the market is a sideways range, then cash should be the investment of choice. The current structure of the portfolio, as well as the depressed nature of the individual names within the portfolios make the potential for another month like October minimal. My sole focus at this point of the year is on managing downside risk in order to preserve the gains the portfolios have experienced in 2012. Barring some type of surprise upside macro event, I cannot see the current structure of the portfolios changing much during November. Activity within the portfolios will be minimal for the foreseeable future.
The time to sink one's teeth into the meat of the market will come in December perhaps. For the time being, the only concern should be making sure that the market doesn't sink its teeth into one's nether regions.
Regards,
Ali Meshkati
