2012 YEAR END PERFORMANCE SUMMARY AND LOOKING AHEAD TO JANUARY
*This is a copy of my letter to investors summarizing the month of December.
Portfolio December Performance: +18.45% S&P 500 December Performance: +0.71%
Portfolio YTD Performance: +58.61% S&P 500 YTD Performance: +13.41%
A list of every individual investment gain and loss made throughout 2012 is available by clicking here.
Portfolio Highlights For December
- Four months of waiting while WMIH essentially carved out a narrow, sideways trading range paid off in December as the stock finished the month with a 75% gain. As noted previously, WMIH has been the largest position in the portfolios for sometime now. A majority of the gain during December is attributable to the move up in WMIH. The best news of all (from my standpoint, at least) was that the enormous run came on no news, and volume that was well above average. I tend to have a greater trust - built up over years of observing price relative to news - of large moves in stocks that do not have a tangible fundamental component to them. The share price is often times factoring in an event that is yet to be made public or word of the positive attributes of the investment has essentially leaked and the price is no longer willing to be accommodating in nature, allowing "cheap" accumulation.
I did not sell a single share of WMIH during the month. Here are the reasons:
1. Our cost basis of around .50 cents coming off of a substantial technical base presents substantial probability that the lows have been witnessed for the name. At the same time, the upside for WMIH continues to be substantial in nature. While a 75% move in a month for a stock is significant by any stretch, WMIH's risk/reward equation is not as far stretched as such a move would imply. This becomes especially true when considering our cost basis.
2. The technical structure of the move in WMIH has been nothing less than perfect. From the volume accompanying pullbacks. To the price and volume action during consolidations. All the way up to the manner in which it creates gains. All of these moves have been textbook in their consistency and favorable nature.
3. Consider this: WMIH has a float of some 185 million (my average investments usually have between 10 to 50 million share floats) shares. Yet, on an average day recently, it has taken no more than 500,000 to 1 million share trading days to cause the stock to put together up days in the 5 to 15 percent range. This tells of a company that is extremely tightly held. We know, for example, that WMIH majority shareholders include large entities such as David Tepper's Appaloosa, Aurelius, Centerbridge and Owl Creek. These large investment management firms received their shares in the same way former shareholders of Washington Mutual received shares, as a result of a court ordered settlement spearheaded by an experienced equity committee. Getting what amounts to a measly number of shares was not the desired outcome for these financial companies. However, that is not the point. The point is that, at a minimum, 100 million of those outstanding shares are not for sale and won't be. The remainder are former retail holders of Washington Mutual who have little interest in this new entity or a dogged resilience towards receiving "a fair and reasonable" settlement through appreciation of these shares. There simply isn't much of a freely traded supply out there, which explains why the company was able to put together a 75% gain during a month when less than 10% of its outstanding float changed hands.
4. The fundamental picture for WMIH remains the great unknown. The original reason I thought this was a good investment (outlined in the research report from July), making it a large position right from the onset, was due to the discount given the stock for that unknown variable. Investors, at that time, were essentially being given a variety of assets that were simply discounted because the difficulty in understanding the valuation. Furthermore, I treated the shares like I would a spin-off, with the understanding that for the first few months a number of investors would magically see a new stock appear in their accounts and be more prone to cashing it out than holding for any potential gain.
The fundamental picture, at this juncture, comes down to the following variables: a) NOLs being utilized during 2013 b) the only operating entity within WMIH (WMMRC operating in "runoff") gaining efficiency and therefore more beneficial to overall market cap. Runoff notes that exist within this entity being difficult to value. However, there is certainly a value to them that the market has not factored in here c) The day after news of Washington Mutual Trustees suing Goldman Sachs (click here for story) hit the wires, WMIH had its largest volume day ever, surging on December 5th. From everything I have been able to gather, any potential settlement only benefits the Liquidating Trust for Washington Mutual. There is no benefit to WMIH. The surge following this news, however, seems too coincidental for my taste. There could indeed be a benefit to holders of WMIH in case of settlement. Still looking for concrete facts with respect to this.
- SPNS gained nearly 8% during December. There were some fairly substantial additions made to SPNS during the month, making it the second largest position in the portfolio currently. I discussed the positive fundamental aspects of SPNS last month. In December, the stock saw its largest monthly volume number in the history of the company, with nearly 4 million shares trading hands. Both the technical and fundamental view of this company remain bullish. An extremely tight float here make substantial gains extremely possible, while the continued positive fundamental performance (with only recent notice by market participants, it seems) cushions the downside.
Portfolio Lowlights For December
- Weakness during the last few trading days of 2012 due to Fiscal Cliff fears caused deterioration in all of my trend indicators that determine allocation of the portfolios. I will admit that the determination of whether to stay put in what was a 95% long position or trim down to a 75% position was one of the more difficult of the past 12 months. The deterioration of the trend indicators, however, flipped my sentiment towards caution rather than being opportunistic. I did start the process on Monday of reducing exposure to a target of 75% long with 25% in cash. I have yet to initiate a hedge with TZA, but will do so on further market weakness.
- PTGI finished the month down 4%, in what I would classify as a bidless drift downward. This is somewhat discouraging given what I feel is an outstanding fundamental value in a long-term turnaround play, as outlined during last month's summary.
- PXLW, UPIP and PRXI were all more or less unchanged during the month in mostly sideways, disinterested trading.
Looking Ahead To January
This is one of the more difficult spots that the market has been in for the past year. There is usually a certain clarity with which I can see the potential direction of the market based on both fundamental and technical factors. However, at present, there is very little clarity from my vantage point. I could make an equal case for a move down to begin the year or a move up. The fact that my trend indicators are all fading simultaneously shifts the balance towards caution, as mentioned previously.
Over the longer-term, looking ahead to the trading environment during 2013, I believe the markets will continue seeing a rather listless propensity towards upward movement that accumulates into gains in the high single/low double digit percentage range for the year. Much like 2012, there will be over-adjustment by market participants on the downside at the first hint of market volatility that will halt any potential bearish move in its tracks. At the same time, a steady creep upward on light volume will keep the abundant number of skeptics either sidelined or lightly invested throughout a bull market that should send the Dow to new all-time highs during 2013.
In terms of overall market structure, I think we are seeing hints emerge of an evolution in leadership in the marketplace. We have recently seen a surge in Transports and Financials, as popular tech names like AAPL, fall behind. In fact, financials were the top gaining sector in 2012, in the midst of tremendous worry involving balance sheet and earnings risk. Technology will continue to have an important role in any market rally. However, the general well being of financials recently will continue to provide the rotation in leadership that is important during any healthy bull market. In other words, this isn't a phenomenon that will simply disappear overnight and will remain an important component within a continued bull market.
I don't expect 2013 to be that much different than 2012. There will continue to be a conditioned, fearful response to any hints of macro disruption. There will also continue to be an overreaction to any potential disruption in corporate earnings, which will remain, more or less predictable for the entirety of 2013. In other words, there will be no great interruptions to what is a financial environment that has been greatly lubricated by a global central bank cabal that is in uncharted territory in terms of coordinated accommodative policy.
What results is a continued, generally favorable environment for equities that will smile upon those who choose to look at companies with a long-term point of view as opposed to anything short-term. There simply will not be sufficient volatility to trade the markets actively, while generating a consistent profit. The bulk of profits will continue to come to those who invest aggressively into the favored sectors of the marketplace.
My policy towards investment will remain the same regardless of market environment: Concentrated positions in well researched companies, with aggressive upside potential, that have a valuation angle that is misunderstood by the marketplace as a result of some type of restructuring or reorganization.
I look forward to continuing the investigation into opportunities that involve minimal risk and tremendous reward during the year to come.
Regards,
Ali Meshkati
