PORTFOLIO UPDATE: HULK SMASH
During the trading day Thursday, I tweeted the following: Let me begin by saying that I am by no means your typical value investor that will simply rely on the aura surrounding improving fundamentals to allow me to hold onto a position. I bring a trading mentality to fundamental investing because I have seen far too many brilliant fundamental managers get absolutely pummeled by completely ignoring price. And don't give me the "what about Warren Buffett" excuse. He has an infinite time frame and equally infinite access to permanent capital that can weather any storm. 99% of investors, whether professional or otherwise, do not enjoy that convenience. Playing this game while ignoring price is like playing football while ignoring your opponents offensive and defensive formations. Sure, you'll still be on the field. But you won't be very good and you won't win many games. With that said, I have been steadily disassociating investor capital from HH over the past two months. The company has very little risk at these levels. However, the small-cap market has witnessed a significant enough degree of injury that numerous opportunities with a higher degree of upside potential now exist. I want cash available to take advantage of those opportunities in Q4. Currently up to 30% cash, giving me enough dry powder to take on 1 or 2 new positions over the next few months. 70% invested in four names total, including WMIH and KFS. Every couple of years an investor is faced with decisions that possess a disproportionately significant influence on future, long-term portfolio performance. This chain of decisions has the potential to positively or negatively influence portfolio performance not just in the coming months, but perhaps years down the road. Every investors chain is different based on their strategy, focus and timeline. However, every investor, whether they realize it or not is disproportionately influenced by decisions made around key points with respect to their specific traits. I have a strong feeling that I am entering one of those periods here in Q4. Being conscious of what I think will be a key point in my chain of decisions already gives me one leg up, I believe. The scope of opportunity being presented paired with what I have found to be significant probability of small-cap outperformance in 2015 and 2016 means that the buying opportunity brought by the current mood of the market can't be misjudged or squandered. I'll be presenting the data for my conclusion that small-cap outperformance will significant in the years ahead next week. Back to writing my client letter for...
A SYMPHONY OF THOUGHTS
Putting together some really interesting studies on a flat to negative Russell 2000 (Russell down 1.44% YTD) and its influence on the rest of the market over the next 12-18 months. I'll be publishing the data in my client letter that will be posted here in early October. This has been a difficult quarter for the small-cap universe. I haven't been spared the lashings despite my attempts at agility through selective rotation out of weaker names and either into cash or names with stronger footing. Liquidity has been especially atrocious, which leads me to believe that, as is so often the case in the tri-dimensional vortex that can become of small-cap investing, companies with market caps under $500 million are simply leaking equity due to disinterest more than actual "real" selling. The ramifications for investors are simple: You either believe this is a buying opportunity, taking advantage. Or you believe that this is a harbinger of an eroding foundation beneath the markets, lessening exposure. For the time being, outside of the Russell, there are plenty of developments taking place that warrant the attention of investors. Here is a symphony of thoughts: - AAPL is tracing out a volatile, above average volume consolidation that typically signals a stock that is ready for a break. The IPhone 6 and 6plus are now out. Inevitable criticism of their new product as well as a short-term hole in new products to announce typically lead this stock into negative territory. Price action seems to be suggesting that weakness is on the way. - In looking through my list of stocks on a nightly basis, if I didn't know any better, I would think all averages are having a negative year. I don't typically follow market breadth, but the recent rally to all-time highs seems extremely narrow. Institutions that dominate this market are increasingly focused on a handful of large and mega-cap favorites, leaving behind a chem-trail of inefficiency in the small to mid-cap complex. To not take advantage of this foolish. Markets will rotate, as they always do, away from what seems indestructible for the moment into the already destroyed. - The Nasdaq Composite is exhibiting the type of erratic behavior that brings with it a weak market over the short to intermediate term. Generally speaking, the setups in large cap tech are disadvantageous for deploying new money. Too much risk is needed for a very mediocre potential reward that has the potential to be taken back in one swoop as demonstrated earlier this past week. - Some of the bargains I am beginning to spot in the small-cap world are ridiculously attractive. However,...
TODAY’S THOUGHTS: CONTROL THE TAKE
Settling in for my nightly perusal of the financial markets on a day when the Nasdaq, in particular, let it be known that holes do indeed exist in the game of September trading. It is by no means a normal act to give up an entire month's worth of gains in one solitary day. However, this is exactly what momentum names decided to do today. The list of names that were caught in the midst of the debacle include my favorites: FB, TSLA, YELP, NFLX all gave up multiple weeks of gains in a single day. A reflection of a market that has been and continues to be high in risk and low in reward. A market, I should add, that has very little in terms of proportional interest of the players involved. The bids are relatively thin. The offers are also somewhat light. Whenever either side of the trade is met with some conviction, a sinkhole opens up beneath the market swallowing investors in rapid fashion. Nowhere is this more evident than my crawlspace: Small-Caps. I have become accustomed to the cyclical nature of the small-cap space that sees investor interest in names ebb and flow like the emotions of a teenage girl at a One Direction concert. When the time comes, however, to deal with the receding of the landscape that is liquidity in small-cap space, it is never an easy task. What is already a group that is ignored by the 99% that occupy the investment space, crawls into a ball and gets buried beneath the soil until it is time shine again. Many of the small companies out there are simply trickling lower not because there is any real selling, but rather due to the fact that there is zero interest presently in taking on risk in small companies. And the primary culprit behind this aversion to risk is plain and simply the fact that investor funds are overly focused in larger companies. This is a market that is driven by institutions who most often ignore smaller companies because of liquidity constraints. The retail investor, of course, still believes that Wall Street houses reptilian demons who sleep under the thick brush of the money forest surrounded by pointy ear elves that are trying to take investor's money. Retail is mostly nonexistent in the small-cap space, barring a handful of popular names that are widely followed. So for small-cap investors nothing is left. The bids are empty. The offers are not met. The price trickles lower. Once the tide turns, however....and it always does, the upside reaction is monstrous in nature. Especially in names that are...
PORTFOLIO UPDATE: CTRL+ALT+DELETE
On Friday, I tweeted the following: Let's first review the micro thesis behind such a seemingly sudden decision. IWSY has always been a volatile investment vehicle. I have been in and out of the name numerous times since I initiated a position and released research in March of 2013. I know very well that IWSY enjoys whipsawing market participants along its path of least resistance, which has mostly been up over the past year and a half. It was no surprise to see the name whip around in the manner it did following the positive news of a major retailer being signed up that was rumored to be WMT. What turned me off with this past week's activity was a realization that I can no longer be sure of how much risk I am taking to achieve any potential reward. The highly inaccurate hit piece that was released this week is surely not the issue. Controversy is the name of the game in early stage technology adoption. There will never be a consensus regarding the validity of the technology or the viability of the company behind the technology. Negative criticism occurs in nearly every stage of a highly-visible technology company's life cycle. It is the reaction to the inaccurate hit piece both in terms of price and volume that instantaneously layered IWSY in what I can best describe as a thick fog of confusion in terms of my risk going forward. If sellers were so quick to damage the name on grounds of a questionable article, what happens if management doesn't execute in the next quarter? Now that IWSY has become a circus of sorts, with competing Seeking Alpha articles, management's threshold for error is reduced remarkably going forward. The price action is screaming that fact here. On the flip side, management will also be rewarded that much more in terms of stock performance with positive developments as a powder keg of volatility is sure to ignite on any surprise positive developments. Again, irrespective of these possible outcomes, I didn't know how much risk I was taking to achieve any type of respectable reward going forward. The situation has become devoid of proper perspective...for me, at least. When that happens, I can't continue in the investment. The macro side of this is grounded in portfolio theory. If an investment manager has a methodology that has a positive expected value over the long-term, then it can be expected that positions that are underperforming can always be replaced with positions that will outperform. The expected value of rotating the portfolio or performing a CTRL+ALT+DELETE reset of the...
QUICK THOUGHTS OF A DISTINGUISHED NATURE
The past few months have been a blur of research intersecting with a suspicious eye towards a market that has been as a difficult to predict as any I can remember in 20 years of investing. There is something to said for human inclination towards the expectation for a reversion. The pendulum that is proportionality is constantly moving in both directions so that we cannot become comfortable with a state of emotions for too long before another state takes over. It is only natural then that we would expect another state to take over the market. This market, however, has proven that it is perfectly fine holding the pendulum of proportional behavior firmly planted to one side. That, of course, being the bullish side, which has shown little interest in abating in recent months. It is often best during times of perplexing price behavior to simply allow the market the freedom to do as it wishes without opinion, as difficult as that might be. Opinion is most easily suspended when you focus on other things. In my case, it has been research. I have become obsessed with a couple special situations recently. This has given way to research that has taken me down roads that I find both entertaining and challenging, at the same time. I've literally spent more time reading over prior bankruptcy cases, court documents, dockets and opinions over the past few months than I probably have over the five years prior. It becomes financial detective work when you have a stake in the outcome that is determined by forming the proper hypothesis, backed by taking the correct amount of risk given the particulars of the situation. Luckily for me, this exercise in financial detective work comes at a time when the market doesn't warrant excessive thought or effort. It's uninteresting in its opportunities, as they are generally being offered with a significant amount of risk. It is taxing in its one-sided persistence, which comes during a seasonally treacherous period for the markets. My focus on the micro instead of the macro is warranted, in other words. When I did my end of the day run through the charts, I noticed the following: - The SOX is in no man's land. No read there. - The financials (XLF) found resistance right at the trajectory from the 2009 low. There hasn't been a real "thrust" downward, however. Neutral reading here. - The Nasdaq has also found resistance at an important trajectory, as discussed in last week's notes. The average could whip around this month a bit more. The more volatile the whip, the more relevant the top. Remember...
CURRENT STATE OF THE MARKETS: THE OLD MAN IN THE HARDWARE STORE
This market of ours will instantly compromise your standing among peers should you remain bearish for more than a week. You are made to seem like that old man at the hardware store telling kids to stay away from his inventory of porcelain toilets and urinals. Aged, decrepit, behind the times. As discussed in my August client letter, despite the new highs in the primary indices, the setups in individual stocks across the board is perhaps as unfavorable as any point during this bull run that started in 2009. You are essentially taking one unit of risk for three-quarters of a unit reward in most situations. Getting 1 to 1 has become rare. It used to be that finding risk/reward opportunities that offered up 1 unit of risk for 3 units of reward was somewhat commonplace. The signs of an aging bull market. Don't get me wrong, aging doesn't mean anywhere near ending. It just means that it is no longer young and glowing in nature. In the following charts I will demonstrate why I have taken the stance of the old man in the hardware store, raising my voice at the first opportunity, warning of the dangers of using garden tools without eye protection. In order to save face, I will end by unfastening my overalls and reviewing my two favorite growth names. Let's begin by looking at the Nasdaq Composite, which I will unabashedly admit to having believed, just a month ago, would be much lower than where it is actually trading at the moment. This conundrum offers us new reason to be cautious as discussed below: click chart to enlarge Next we look at the S&P, which is just hanging around an important technical point that could cause it some grief in the near term: And now the Dow. Another floater: Let's now turn our attention to two simple reasons to be optimistic. My favorite growth names, in the form of FB and TSLA. By no means should an investor expect both of these to make them an abundance of capital over the next few months. They could very well be prone to a pullback, which would be perfectly fine. However, if you are a believer in this bull market over the long-term, as I am, then these are the names that you want to be concentrated in. FB and TSLA lead the pack. Innovative, growth oriented, trail-blazers of Silicon Valley that are equal parts fundamental and technical prowess. Let's...
CLIENT LETTER: THE FAILURE OF HUMAN INTUITION IN FINANCE & POSITIVE EXPECTED VALUE IN DECISION MAKING
What follows is the “Looking Ahead” portion of my monthly letter to investors at T11. I have created an email list that sends this report out at the beginning of each month to those interested. The full report contains commentary about the general markets and individual positions held in managed portfolios, as well as overall performance. To be added to the list email me at mail@T11Capital.com With a profession such as investing, people see the “doing” as the buying and selling. It is difficult to come home from work, and answer your spouse’s question, “what did you do today?” with “well, I read a lot, and I talked a little.” If you’re not buying or selling, you may feel you aren’t doing anything. We believe in diversification for risk reducing, but we don’t want to diversify ourselves into ignorance. If we can do three smart things a year and nothing dumb, we will be very successful. If we can do five, that’s a home run. – David Abrams, worked under Seth Klarman, now runs Abrams Capital Management The business of investing has caused madness in some men who thought they were on the precipice of financial immortality, only to later find that the theories they placed their faith in had fatal flaws revealing the desolate terrain lying beneath the beautiful mirage. It has brought incomparable joy to others who have achieved great success whether through sheer luck or unique skill. The ability to achieve consistent success in the business of investing automatically vaults the individual into a category of analytical genius whose words can be relied upon to navigate the often random waters of day to day or month to month market movements. At its essence, what drives one individual down the path of madness and another individual down the path of genius are slight degrees of separation along the very same path. It is indeed a game of inches where the quality of decisions made means everything. It is also a game where quality will always trump quantity. It is, in fact, true that the more decisions one is forced to make in any speculative venture, the more their results will fall towards the mean and eventually far below it. Speculation, in any form, does not agree with attention deficit disorder as it applies to decision or indecision. The counter-intuitive nature of speculation is perhaps the biggest stumbling block that an investor will consistently face during their career. Everything that one is taught to function in normal society leads to madness, sorrow and depression in finance. If you were to see a large crowd running away from something...