WHAT IT TAKES TO OUTPERFORM IN THE CURRENT MARKET ENVIRONMENT
When I first started writing my views publicly in January 2011, the environment was absolutely ripe with opportunity. It allowed for a wide swath of ideas or picks to be had without much worry for downside given the excessive pessimism that provided dark cloud cover from which those opportunities were born. At that time, it was delightfully obvious to profit-minded individuals that the markets were setting up for something dramatic on the upside, as the mix of pessimism, excess liquidity and accelerating growth created a near perfect environment for unexpected upside. We are now in the midst of the upside that I spoke about on a near weekly basis in 2011 and 2012. The environment we are in today, while retaining opportunity for profit before risk of loss, has become much more challenging in nature. The first month and a half of trading in 2015 demonstrates the challenges perfectly. In fact, the last six months of trading demonstrates the challenges. The challenge comes from the fact that there is no longer imbalance bubbling beneath the surface of the market, forcing investors into uncomfortable situations that have a perceived uncertain outcome. There is a great degree of certainty that profits will grow, the economy will remain resilient and asset prices will appreciate. That certainty is the problem. It is that certainty that causes risk/reward on stocks to become balanced, not allowing investors to take on positions at points that are advantageous. Instead, investors must hold hands with other investors who are just as certain to the future outcome of an investment, creating efficiency in the pricing of the asset, which leads to greater risk for decent reward. It also leads to good deal of backing and filling, to borrow a technical term. Or sideways trading, if you prefer. No-brainer opportunities are few and far between, whereas several years ago they were plentiful for those who embraced uncertainty and the imbalance that it brings to pricing of equities. Such is the nature of a bull market, however. As it progresses, more investors become involved, bullish ideology experiences a convergence along a singular path and pricing of equities becomes balanced. Balance, as I pointed out in a recent client letter, creates difficulties for investors due simply to an excessive number of participants all looking for abundant joy on the same roller coaster. That roller coaster will inevitably slow down as more weight piles on. The ride is not nearly as fun as when there were only a few onboard with the ride ripping to new heights as a gaggle of onlookers were still undecided as to whether they wanted to get on. Investors...
CLIENT LETTER: DESPERATELY SEEKING IMBALANCE
What follows is a portion from the monthly client letter I send out to investors at T11. The seeds planted in 2014 are already bearing fruit in the form of significant gains to begin 2015. Throughout the years I have been a part of enough January jubilation, if you will, to realize that while a strong start to the year is certainly the best possible outcome, the market is fickle mistress that can quickly decide that castration may be the next best course. To reiterate the review for December, the market of 2014 did afford a great deal of opportunity in terms of situations that were simply not being recognized. Discovery of those situations followed by the strength of conviction to take a substantial position has dictated our gains to begin the year. There are a number of factors at work that lead me to the belief that we will see a minimal amount of turnover in the portfolios over the next eleven months. The evolution of a bull market dictates that in the middle of the cycle attractive opportunities become scarce due to the recognition of what is occurring by investors. That recognition disallows an investor from receiving an appropriate amount of reward for the risk they are taking. The situation for investors moves into a balanced phase that very obviously creates volatility in returns as an investor decides to settle for less than ideal circumstances expressed through the act of taking on investments that can be best described as “discovered.” It is only through imbalance that significant returns are possible. The counter-intuitive nature of the markets dictate that balance is an adverse circumstance that should be summarily avoided. However, it is all too common that investors find comfort in the intuitive act of investing into a balanced situation. In the current phase of the bull market there are very few perfectly imbalanced situations. I like to think that our portfolio is an amalgamation of the most attractive imbalanced investment situations remaining in the marketplace. Of course, I come across a handful of potentially imbalanced investment situations every month. There are degrees to imbalance, however, that cause those situations to be filtered out. In reality, I scan through literally hundreds of names per month. Over the course of the year, that number jumps into the thousands. In 2014, five of those thousands of candidates made it onto the big screen instead of being discarded onto the cutting room floor, to borrow a phrase from Hollywood. In fact, each successive year from 2012 on has caused a more discriminating process of allowing for investments to actually make into the...