CONSERVATIVE ARROGANCE IN A BULL MARKET
In browsing through the noise with a focus on discovering the rare signal that emanates from within, I made the mistake of reading a blog posting from a financial advisor in which he unabashedly advocated a significant cash position in this bull market. I skimmed through the remainder of the article which cited various elementary arguments for remaining conservative in the face of an extraordinary bull market. There is a certain degree of arrogance that comes with the opinion of maintaining a significant cash position in this market. Cash is not a position. It is, in fact, an opinion. The degree to which you remain in cash is the degree to which you disagree with the act of equity appreciation. For example, a 10% cash position with a 90% allocation towards equities is significantly bullish opinion about future prospects for a bull market. A 50% cash position within a secular bull market, on the other hand, is a significantly bearish opinion with respect to the prospects for future appreciation. The arrogance disguised as conservative stewardship of capital comes from the act of disagreeing with a bull market that has been as consistent and steadfast in its appreciation as any of the past 100 years. It is always easy to argue bearish points because they appeal to the pseudo-intellectual crowd who grasp onto seemingly sophisticated measures of value or pending disaster that are predicated on data points subject to massive range expansions during a bull market. As an example, it was about two years ago that nearly everyone was clamoring about margin debt levels being sky high. Voila! Two years later we are at record highs and margin debt levels have expanded even higher. The "normalized" range has expanded. Everything from simple valuation measures to more sophisticated monetary measures are subject to expansion during a secular bull market. What you consider normal at the beginning of a bull market becomes stretched, contorted and disfigured to the point that it is unrecognizable by the time it all ends. In other words, it is all noise, with no signals. As this bull market continues, more seemingly influential investors will sound the warning bell that all is not Le Beurre d'Echiré butter and warm French Bread at the dining table. They will argue that what we are in fact being served is a steaming plate of merde. This consistent hum of noise will do its job to either dissuade investors completely or jostle them out of their existing positions. Despite the powerful tool for wealth creation that a secular bull market provides, very few actually take appropriate advantage. The sole reason behind this...
THEY DON’T RING BELLS AT MARKET TOPS
I'm not certain if the sell-off we experienced on Friday was the beginning of a multi-week or even multi-month bear raid on the markets. However, I am certain of the fact that they don't ring bells at major market tops. There will be a growing voice in the months ahead, as we embark on a Federal Reserve that will be raising rates for the first time in forever, that the markets cannot properly contend with a tightening stance. That the bull is an old, decrepit, worn out shell of its former self that can't lift itself off the ground with Janet Yellen's foot firmly implanted on its genital region. Not only does that opinion lack historical relevance when compared against other periods of tightening, where the market has gone onto much greater heights throughout the tightening cycle. But it buys into the fact that market tops are announced in bright lights and booming voices. In fact, major market tops are announced in quite the opposite fashion. It is the lack of chatter you see opposing the view that the indices are moving infinitely higher that accompanies major market tops. It is an abundance of news justifying the group mentality that sees endless prosperity ahead. It is a lack of tangible bearish information that short-sellers or general pessimists can hang their hat on as a reason to remain gloomy. The prospects of a series of rate hikes moving forward gives bears everything they want from which to hang their raggedy hats. Eventually others will join that are not quite in the bearish camp, but are persuaded by seemingly logical misinformation. That very prospect of quickly rising bearish sentiment that has a seemingly fundamental basis for its pessimism is exactly why we won't see a major market top on Fed news. When the day comes that this secular bull ends, it will be marked with absolute conviction that the markets will remain solid indefinitely without one shred of fundamental evidence to dissuade the faithful. This isn't...
THE PATH TO DISCOVERY OF NEW OPPORTUNITIES
The Roth Conference in Laguna Niguel kicks off this weekend. I rarely attend conferences. However, this one I am always torn about because it is literally walking distance from my house. To know that there is a large group of individuals talking small-cap stocks within spitting distance makes me feel that I'm missing something. I'm a bit of stock market hermit, if you will, when it comes to surrounding myself with individuals that want to provide me with information from which I will make an investment decision. I keep that circle of influence extremely tight, rarely allowing for anybody new. In fact, my new ideas are mostly generated from a series of market screens I run on a daily basis. If an idea doesn't come up on my screens, then it simply doesn't exist in my world. The prevalence of opinions and ideas that is the hallmark of conferences such as the Roth Conference is actually frightening to me professionally. Let's think about what occurs at these conferences logically: Fund managers are there hungry for opportunities to capital gains. Companies are there to promote themselves to these managers being hungry for investment capital and recognition. So you essentially have two eager individuals of equal hunger coming together countless times over a span of several days. The possibility of erroneous decisions being made within such an environment are extremely high due to both the salesmanship that is taking place on a corporate level and the desire to justify reams of information being digested on an investment management level. Emotionally overwhelming circumstances abound, in other words. If there was a record of the success investors had at these conferences in finding viable candidates it would extremely valuable in proving my point. The point being that these conferences are equity busters. Meaning that on a net-net basis the expected value of decisions made as a result of these conferences are negative. If anything, there may be a positive curve in favor of the companies presenting because they are able to garner a short-term boost as a result of the attention gained. However, from an investor standpoint, being sold on an investment by management is not the ideal path towards investment discovery. The path towards discovery of opportunities should be unbiased, unsalesman like and process driven. I'll just stay...
THERE IS NO EXIT POINT
If you are an investor in a company, you cannot have an exit point unless it is on the downside. In other words, the only time you should be concerned about an exit strategy is when you are in the process of consistently evaporating equity at the hands of a particular stock. By consciously having an upside target to sell your stock you are creating an expectation that will often times not initially be met, thereby justifying selling the stock at a lower price when your disappointment turns to despondency. Eventually you watch as the stock blows past your initial exit point, going onto further gains above and beyond anything you, as an investor, expected. This becomes especially true in a secular bull market. I started my career on the retail trading desk for Waterhouse (now TD Ameritrade) in the mid-90s. You don't know how many investors I saw sell names like AMZN and YHOO when these names went onto create absolute fortunes for investors into the 2000 top. To loosely quote Jesse Livermore, "There are lots of early bulls in a bull market, but the man who can be right and sit tight is rare." I consistently remind myself of the lessons learned two decades ago in order to properly capitalize in this bull market. Exit points are amateur-hour. Control your downside and allow the upside to flourish unencumbered. ...
CLIENT LETTER: IF AT FIRST YOU SUCCEED, QUIT TRYING
What follows is a section from the “Thoughts & Analysis” portion of my monthly letter to investors at T11 Capital. 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 I thought it appropriate to rename this section after feeling that the obligation to "Look Ahead" was preventing me from discussing various thoughts, analysis and philosophies that are an important parts of my process. It is also true that as an investor in the markets, I don't want to necessarily be sidetracked by short-term analysis, although I have been relatively immune from confusing short-term thoughts with long-term objectives. I have no desire to risk my immunity, however. Just as there are various imperceptible laws that govern human affairs, it can only be assumed that similar laws will also dictate the affairs of the financial markets. After all, financial markets are simply a reflection of the perception of a particular group at any given moment. This group, as opposed to the popular perception of seeking a balanced state, remains in the constant realm of disequilibrium. Markets are never balanced in nature, as balance inherently suggests predictability of an outcome. Proportionately as it applies to the financial markets dictates that disproportionate cause will lead to disproportionate effects. There has been no better proof of this law at work than what we have experienced with the near vertical run that has taken place since the 2009 bottom. The current bull market was born from a disproportionately negative circumstance that was singular in its scope and breadth. The accompanying reaction that took place in terms of monetary policy was also disproportionate and singular in nature. The law of proportionately will dictate that the effect of such disproportionate negative circumstances should be equally disproportionate on the positive end. This is simply how proportionately works. The further you stretch the rubber band to one side, the more powerful the reaction will be to the opposite side. The greater force you use to hit a tennis ball into a wall, the greater force it will exert on its return to your racket. This is proportionately in its simplest terms. Already we are seeing clues in the form of the extraordinary persistence this market has had on the upside. There have been numerous reports of record stretches without a 5% pullback in the major averages. There has been a record stretch of months without a touch...
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...
AN EDGELESS ENVIRONMENT THAT IS SET TO CONTINUE
There is no secret to it, really. We are in an absolute edgeless environment that deserves less of your attention than you are presently giving it. In fact, I shouldn't even be writing this article to give this environment credence. If you go back to September of last year, you will find most of the major averages in pretty much the same spot that they closed at today. Meaning that for the past four months the markets have done absolutely nothing. It has been a constant back and forth between earnings worries, macro fear, interest rate hysteria and an occasional global pandemic thrown in for good measure when the pity party starts slowing down a bit. I'm not here to dissect the indistinguishable and abstract, as is the norm in the modern day finance. Let's leave the professorial sermons to the professors of finance, of which the news pages, blogs and websites are filled the brim. My sole purpose is to make money for my clients and for myself. To increase capital as opposed to propagate illusory facts that serve no purpose other than to complicate simple situations. With respect to making money, the current macro-market situation is extremely simple: We haven't moved in four months as previously stated. The major averages are down less than 5% from their recent highs. In the meanwhile, pessimism as measured by long-term moving averages of the put/call ratio is higher than at any point in 2013, nearing the highs of 2012, below the levels of European crisis of 2011 and nearly matching the highs of 2010. Simply put, the only time the market has been demonstrably more pessimistic than this current moment was during the European crisis of 2011. Here is the chart of the combined put/call ratio using the 20 and 100 day moving averages only. Notice the level of the 100 day moving average in red: What does this mean for investors? Any breakdown of the recent choppy, sideways ranges for the market averages will not result in sustainable downside pressure. At worst, the averages will move back into the ranges we have become accustomed to over the past few months. At best, a breakdown in the recent ranges will develop a swelling of pessimism great enough to put in a sustainable bottom from which the markets can rally. In any case, this is not the time, place or psychology that leads to 10%+ declines, eventually leading to the lopping off of investor limbs. It's a situation where the best course of action remains little to no action. Point is that the desire to become overly-defensive at this juncture...
WANDERLUST
This is garbage. The start to 2015, I mean. I'm not talking from a personal performance standpoint either as I have avoided ice skating in molasses through the act of being long a group of names that are outperforming through the first few weeks of the year. WMIH, IMH and KFS make up a bulk of long exposure with a significant possibility of it remaining that way for a long time to come. The reasons why are rooted in the fact that outstanding risk/reward opportunities simply do not exist in this market any longer. You are giving up a significant degree of risk to achieve a reasonable gain. Not the type of odds deserving of capital. As for the garbage that has managed to seep into the veins of the current bull, it comes in the form of disobedience in the face of strong seasonal tendencies. You see, these seasonal tendencies, of which the vaunted January rally following a strong year for the market ranks high, have rhyme and reason behind them. They are not simple random events that just happen to occur during a specific time span dictated by a the flipping of the calendar. When rhyme and reason fail then the astute observer of the markets must ask the question, what could it be that I may be missing? It is similar to the spouse who comes home every day at 4:30 and the one day, without warning, decides to show up at one in the morning. The sudden, unexplained aversion to natural tendency cannot simply be dismissed. Odds are that something is brewing beneath the surface. So the market in its wanderlust has decided to avert itself from a positive January, instead performing a volatility dance that is unpredictable in nature and frustrating to those involved. Of specific concern is the Russell 2000 given that January is supposed to favor small-cap names as investors put money to work in high-beta outperformers. It's simply not happening. There are a million reasons as to the possibility of why? I'm not here to act like I'm smart enough to pull the "why" out my hat. What I am here to say is that anomalous behavior shouldn't be dismissed whether on the macro or micro front. What we have here is an anomaly across multiple asset classes that is deserving of a perking of the antennae until we are given more information. Until then, stay...
PORTFOLIO UPDATE: ALL THAT VOODOO
During the trading day last Friday, I tweeted the following: In a year that has been marked by taking pride in what I've liquidated rather than anything held, I made the decision early on not to allow SGGH to get away from me on the downside. Steadily began scaling out of the name in the 8 range starting in November and finished selling last week. Not at all comfortable with the way the name has been trading as they attempt to raise the capital needed to pursue their acquisition. Some of that discomfort comes from the fact that I'm having a difficult year in terms of performance, which automatically creates less of a tolerance for buffoonery in new names. Another part of that discomfort comes from the fact that the company needs their stock for currency in order to facilitate the acquisition. The further it drops, the more expensive the acquisition becomes for management in terms of overall costs. Lastly, the company SGGH is attempting to acquire is tied to commodities, which are in an absolute royal rumble at the moment. Anything related to the sector could see some outsized volatility. Didn't want to sit through that when other opportunities exist to profit. I will be watching the name into 2015 to see if there is an opportunity for reentry once everything is ironed out. In January, I should have a new research report on a financial name that I have been accumulating since November. What looks to be a really outstanding opportunity in what was formerly a significant sized company. I'm working on putting together the research as I continue to slowly accumulate shares. It is difficult name to accumulate due to the lack of liquidity. As for the general market, the opportunity remains to the upside. The power with which declines are being bought is not euphoria or signs of a bubble as popular perception seems to dictate. Rather it is a testament by the market of the underlying bid that continues to exist in equities. What should be kept in mind is that since the beginning of this bull, this market has exhibited a pretty consistent tendency towards rotation. Early on it was from financials to tech. Then it was from small-caps to large cap names. Now it looks like the next great rotation is from "new school" tech, which are companies that I would be define as being around since 1995-present, to "old school" tech, which are well established technology companies that blazed the trail for the technology we are all so familiar with today. Think Intel, Microsoft and Oracle. I do believe that the outperformance of...
WHY IMMEDIATE LIQUIDITY IS THE GREATEST CURSE TO EQUITY INVESTORS
Imagine for a second that the real estate market in the U.S. was as liquid as the stock market. That home prices for every single residence in the country traded on an exchange that could be accessed each business day. Imagine that selling your home was as simple as clicking "sell" and you would have a predetermined amount of time to move out. Actually, let's make it even easier than that. Let's say as part of this real estate liquidity program, within 24 hours of selling your home on the real estate exchange, movers automatically show up, pack your belongings and send you off. Now let's assume the opposite were true for company stock. Imagine that stocks took months to sell. There was a tremendous amount of paperwork involved. The value of your stock wasn't quoted daily. If you wanted to sell your stock, you had to physically move a portion of the furniture, equipment or machinery at the company to another location. In other words, there was a tremendous amount of work and inconvenience involved. How would this reshape the ability to produce profits in both of these assets? Investors I have met over the past 20 years have managed to produce tremendous profits in real estate, while very few have held onto their profits in the financial markets. Is this because the stock market is difficult? Is the stock market rigged, as some would have you believe? Has this been an adverse period for stocks? Is there something about real estate that makes it more steady and simple for the average investor? Accessibility is the at the root of the answer to the question of why individuals fail at stock speculation at a much greater rate than real estate speculation. The fact that the stock market is quoted on a daily basis allows for emotions to get involved. Further, the ease with which you can move millions of dollars, allows for emotions to be acted upon in a feverish manner, avoiding deliberate, careful judgement while embracing fear and uncertainty. For the average investor, real estate doesn't allow for emotions to get involved. In fact, it plays into the human tendency towards laziness given that selling a property involves both time and effort. And this is why investors, for the most part, are much more successful in buying and holding real estate than they are with stocks. In the real estate market, individuals are being rewarded for human traits that come naturally. In the stock market, individuals are punished for human traits that come naturally. The individual investor in the equity markets is being manipulated on a daily...