FOLLOWING UP ON THE “SCREAMING BUY” SIGNAL FROM OCTOBER 30th
When we left off on October 30th, I posted an interesting study that pointed to the markets being a screaming buy, with an average gain of close to 17% over the next 12 months. Being that we are up roughly 10% since the study was posted, I thought it would be appropriate to post a follow up, along with some relevant notes. Let's start off with a philosophical discussion: Bull markets are meant to be invested in not traded. There is more money wasted and opportunities lost by investors who simply attempt to avoid the pain of a pullback in a bull market. The pain and pleasure of the ebbs and flows of bull markets shouldn't be avoided, but rather, understood. The understanding comes in the form of observing the natural tendency for markets to correct while knowing a correction does not constitute a secular reversal. It has been 6 years I have been telling any investor who would listen that this bull market should be bought and embraced for sometime to come. That message has not changed and it will not change at any point on the near horizon. There are still multiple years of gains ahead, into the end of this decade and perhaps further. In fact, the upside from here remains on par with the potential I saw in 2011, when the Nasdaq was at 2500. In the meantime, the markets are at a complicated inflection point. We are up against some substantial resistance areas but sentiment is just beginning to turn into the bullish camp on a long-term basis. Typically when that sentiment turn occurs there is a prolonged period where what is obvious becomes obviously right. In other words, contrarianism fails while consensus excels. That was the point I was attempting to convey in the article from October 30th, titled An Unorthodox L0ng-Term Indicator Is About To Scream Buy Going back to the same indicator mentioned in that article, the 260 and 600 day moving averages of the put/call ratio, you can see in the chart below that the crossover just happened. Again, this indicates we are entering into a period when consensus bullishness will prevail much to the disappointment of contrarians: Next up, we have the Dow, which has broken out above a key trajectory point with this recent run since November. This is a very real breakout with significant ramifications. This is the beginning of the second leg up for this bull market that has the Dow moving much higher over the next 2-3 years. The stick in the wheel comes in the form of the Nasdaq which is camping...
THE BRILLIANTLY PERILOUS TIMES AHEAD
What follows is a section from the “Thoughts & Analysis” portion of my monthly letter to investors at T11 Capital. A sense of absolute clarity has suddenly developed within the minds of investors in U.S. equities. A clarity as to the future of the economy. A clarity as to the future of the markets. A clarity as to the future of their own personal fortunes. This clarity has been thrust upon the hearts and minds of investors from one source: Government. The changing of government that will take place in earnest later this month ushers in an incubator-esque, pro-business environment that the country has never experienced. It is only appropriate that in the face of pro-business policies, designed by individuals who have a lot of money, for people who want to make a lot of money, that the markets would applaud loudly by driving up equity prices to record levels over the past couple months. That very same comfort and clarity, however, creates some of the most perilous conditions we have had in all the time the markets have been advancing since 2009. There is a premium that has now been baked into the market based on governmental policy and action. In the past years, we have only seen premiums baked into the market for earnings and monetary policy reasons. The current affinity for fiscal policy, whether in the form of stimulus or deregulation, reflected in the premiums individuals are suddenly willing to pay for stocks, changes the game completely going forward. Investors have now tied themselves to a group that has influences from an infinite number of outside groups that have contradictory interests tied to numerous other groups. This is no longer a game if earnings are good then markets will rally; if monetary policy remains accommodating then the markets have a base from which to rally; if geopolitical and macro uncertainty stays out of the picture then the markets will appreciate in value. Things just got a lot more complicated while investors have become extremely comfortable with their investments. How comfortable? Take this comment from the CEO of Trimtabs as one example: “The stampede into U.S. equity ETFs since the election has been nothing short of breathtaking. The inflow since Election Day is equal to one and a half times the inflow of $61.5 billion in all of last year.” Investors, in other words, have digested all of the positive soundbites coming from various media sources and have concluded unanimously that they are underexposed to equities. And this note from Bank of America courtesy of ValueWalk: ETF buying by Bank of America’s retail clients was the fourth...
AN UNORTHODOX LONG-TERM INDICATOR IS ABOUT TO SCREAM BUY
The combined put/call ratio is a useful tool to measure sentiment, yielding contrarian driven results that are beneficial to an investor more often than not. There are other ways to use the put/call, however, beyond your simple when the put/call moves up to X level then the market should be bought as pessimism is excessive and when it moves down to X it should be sold as optimism is excessive. Some pretty impressive results can be had from examining two very long-term moving averages of the put/call ratio, in this case the 260 and 600 day simple moving average, with the intent of studying what happens to the markets when these moving average cross. Think about what it means for just a second when these two long-term moving averages cross. It's a pretty important indicator of comfort or discomfort with a market, not in a contrarian sense, in that comfort equates to complacency. But, rather, in a very real sense, as in this case it equates to comfort that has evolved from some very pessimistic conditions prior. With that frame of thinking in mind, when the 260 day moving average crosses below the 600 day moving average, it represents capital becoming comfortable moving back into the markets following a pronounced period of pessimism. The 260 day moving average is above the 600 day moving average exclusively during recessions and panics. It represents an investor class that basically hates the market. The 260 day moving average going back below the 600 day moving average represents an investor class that is warming up to the market again, with capital moving into risk assets. Here's a look at what happens to the S&P 500 12 months following capital becoming comfortable with the market as reflected by the put/call ratio: click chart to enlarge The most impressive part of this study is not the average gain of 16.87% in the 12 months following the sentiment shift, but rather the fact that the maximum drawdown once the cross takes place averages 2.2% when the signal is taken at month end once triggered. Essentially, once this sentiment shift takes place, the markets simply take off, without much in the way of looking back over the next 12 months. A slice of apple pie amidst the chronic pessimism and indecision investors face at this juncture....
SEPTEMBER CLIENT LETTER: LET’S GET NORMAL; A WICKED GAME TO PLAY; BUY COMPLEXITY, SELL SIMPLICITY
What follows is a section from the “Thoughts & Analysis” portion of my monthly letter to investors at T11 Capital. The stock market is a giant distraction from the business of investing. ---- John Bogle Let's Get Normal The Delivering Alpha Conference took place in September. Delivering Alpha, for those who are not familiar, is basically a conference where high level fund managers take the stage for an interview where they discuss opinions about the markets, economy etc. Here is an excerpt from an interview with Marc Lasry of Avenue Capital worth noting: Caruso-Cabrera: We were chatting and we had our conference call beforehand. And you made the point in saying that a while ago you gave up on quarterly redemptions. If you want to give me your money, you have to give it to me for three years. No more hedge fund. Why? Avenue Capital Group CEO Marc Lasry: Because I think it's gotten extremely difficult to invest on a quarterly basis. I think before, when you weren't in a zero-rate environment, a zero-interest environment, it was actually easier. But now, you actually need the luxury of time. And because sometimes things will go down, so you need to invest over a sort of two or three year period. Or not have people who get nervous who automatically want their capital. And I didn't think we could generate the returns for people if we did that. So mainly we just went to our investors and said we're going to shift anybody who is here to lock up to about three years. And whoever doesn't want to do that, you can leave, and about 75 percent of the money stayed and 25 percent left. In recent years, it has become of increased importance to recognize that the runway towards an investor recognizing value in a stock and the market recognizing that same value has lengthened substantially. The markets as a whole have become reluctant to assign value to uncertain situations. Given that we just so happen to dwell in the realm of murkiness and uncertainty, this dynamic will certainly effect the pattern of returns until the dynamic changes or our positions move into more certain fundamental positions that will lead to a sudden rush of value creation. What we are truly experiencing in the current zero yield market environment is an expression of emotion rather than an expression of intellectual understanding. Investors globally are telling us that they are too fearful, skeptical and indelibly scarred to put capital at risk. This is an extreme emotional reaction to unprecedented action by global central bankers caused by a once in...
AUGUST CLIENT LETTER: THE SMALL-CAP MARKET OF 2016; “I’D RATHER EAT ROCKS THAN BUY STOCKS”; THE NARROWS
What follows is a section from the “Thoughts & Analysis” portion of my monthly letter to investors at T11 Capital. The Small-Cap Market of 2016 Since 2014, small-cap investors have been treated to a sideways market, with a 27% peak to valley drawdown thrown in for good measure. The pricing environment for small company shares paired up with a near chronic pessimism that has incrementally advanced since the 2009 bottom has led to a trading environment that is tremendously illiquid and severely mispriced in certain areas. In small-cap investing, there will always be pockets of mispricing as the market simply is not efficient enough to correctly price thousands of companies with scant or nonexistent analyst coverage. This simple phenomenon leads to the opportunities that become available to investors over time to profit from these blatant inefficiencies in the marketplace. In 2016, however, the simple phenomenon of mispricing has taken on a new slant. Securities pricing is being graded by difficulty. The more difficult the situation, the more likely it is that the company will be mispriced. Companies that release relevant, easy to digest information regarding products or partnerships that are recognizable to investors are properly rewarded through premiums in share price. However, situations that are opaque, difficult or those possessing variability in outcomes are largely ignored. This leaves special situation/event driven investors reliant upon their analysis to be correct more than ever because the market simply won't assign a premium based on expectations of success, but on success coming to fruition in a tangible, recognizable way. In some ways, the public equity market for companies with market caps under $500 million has become similar to private equity or venture capital in 2016. Value is taking longer to realize in an environment that is not necessarily liquid but rewards tangible results over time. Gone are the days of blanket adjustments up in the price of shares based on a sector or general market movement. Companies are being left behind in favor of tangible performers with tangible products and partnerships. This leaves the special situation/event driven investor in a position that demands a mentality in step with the times. Managers have a relatively simple decision to make: 1. Conform to the current market cycle, seeking out opportunities that the market sees as relevant. Essentially becoming a growth investor rather than a value investor. 2. Adjust your mentality to fall more in line with that of a private equity or venture capital investor that is dealing in the public markets. Very simply put, assuming that you disagree with the first choice, deciding that maintaining an edge in the markets is...
MADE A U-TURN ON RELY: THE REASON WE ARE ALL OUT
In what is an unusually swift u-turn for the portfolios, I exited our position in RELY during the month of August, resulting in a roughly 1% hit to overall performance, after initiating the position in July. With every position that is established within the portfolios, there are certain fundamental elements that should remain intact or on track in order for us to remain in an investment. Every situation is different, making the list of fundamental faux pas vary among our investments. In the case of RELY, the CEO Craig Bouchard was a key element in the overall strategy, as it was abundantly clear that the first acquisition made was the first in a series of acquisitions, with subsequent acquisitions being what would drive profitability going forward. In order for their strategy to be successful, the presence of an excellent asset allocator was of obvious importance. Mr. Bouchard struck me as an excellent asset allocator, understanding the various nuances of rolling up several companies in an effort to create a highly profitable entity with significant tax attributes. So when it was revealed during August that Mr. Bouchard had resigned his position, it struck me as both extremely surprising and a sign of trouble in a highly leveraged company that simply cannot handle trouble in the slightest given their current debt load. Perhaps more than any other company in the portfolios, RELY was CEO dependent in order to see their mission through. The fact that they switched out quarterbacks in the 2nd quarter during a game that they seemed to be winning is an oddity at best and a sign of a failed initial acquisition at worst. Oddities in leveraged situations, especially in the volatile field of raw materials, are best left to the daredevils among us, of which I don't count myself as one. Further, admitting that the first acquisition was ill-advised, which is essentially what Bouchard resigning or more than likely, being fired, points to, means that the company has a very long road ahead in terms of righting that initial wrong. A process that I am not necessarily interested in being part of due to the leverage involved. Lastly, it should be noted, that among value/special situation/event driven managers, I consider myself to be especially cognizant of risk. One of the worst habits of your typical, garden variety value manager is the belief that a value stock becomes that much more valuable when it moves lower. The tendency among the traditional investment community is to see greater value in the name instead of question their own thesis. My initial reaction whenever a position goes against us, especially right...
RESEARCH REPORT: ARIS NETWORK SERVICES (ARIS)
The most recent research report for T11 Capital Management's newest holding ARIS is available below: Download (PDF,...
JULY CLIENT LETTER: THIS THREE YEAR OLD BULL MARKET; UNDERSTANDING FORM AND RHYTHM
What follows is a section from the “Thoughts & Analysis” portion of my monthly letter to investors at T11 Capital. Thoughts & Analysis This Three Year Old Bull Market One of the many issues that investors face in the current environment is their inability to accurately gauge the age of the current bull market. The traditional argument has been and continues to be that the current secular bull market must have started at the 2009 bottom simply because stocks have been moving up since bottoming at 666.79 on the S&P 500 seven years ago. What investors seem to overlooking when they argue that a bull market commences at the point of reversal and subsequent long-term appreciation is context. The context that is being missed in our most recent example is that the S&P 500 had made a low of 768 back in 2003 after the secular top in 2000 to the 18 year bull run that started in 1982. The 2009 “credit crisis” bottom of 666.79 was a thorough retest of the 2003 lows, constituting what was essentially a long-term sideways range for stocks that is typical of the end of a secular bull run. For example, when the Dow topped in 1929, dropping from a high of 386 to 40 in 1932, the subsequent volatile sideways range took place over a span of 25 years, marking multiple starts and stops before a new all-time high and a new secular bull market started in 1954. Those who took it upon themselves to correlate the age of the bull market to the simple act of stocks moving up at that time were sold on the idea that the bull market was 18 years old simply because stocks bottomed in 1932. The truth of the matter in 1954 was that a secular bull market was just being born. A secular bull, by the way, that would triple the value of the Dow over the next 13 years into the 1966 top. Subsequently, a sideways range emerged that saw stocks go nowhere from 1966 – 1981. Along the way there was an initial bottom that took place in 1970 with a low of 627, which surely had market participants reeling after witnessing a near 50% drop from the all-time highs in the Dow just four years earlier. It didn't end there, however, much like the initial low on the Dow in 2003 after the mess leftover from the internet bubble started to mend, that would not be the ultimate low. The markets had one more bearish act in store for investors to completely dissuade them from purchasing equities over the next...
BACK IN REAL INDUSTRY (RELY)
There is some history here with this company, so let's do a brief review. I originally released the research report on RELY (back then it was SGGH) in October 0f 2014. The company had just made its acquisition of the aluminum recycling subsidiary of Aleris Corporation. Just a short while later, in December 2014, I exited the position due to a number of reasons, including wanting to raise cash to allocate into Impac Mortgage. On Monday, I reinitiated our position in RELY at what is roughly the same price I exited in December 2014. There have been some material improvements taking place at the company that are worthy of mention. Also, the fact that RELY escaped what was a brutal year for commodities (aluminum included) unscathed, marks an important test for management that they passed surprisingly well. For me, this is an example of the market telling a story through price that fundamentals have yet to properly capture. For all intents and purposes, given a depressed commodity market in 2015 and the newly minted, leveraged state of the company, RELY should have suffered much more than it did. The fact that it did not is a clear tell. Here are some of the material improvements/catalysts coming into play for RELY: RELY generated $81 million in EBITDA in 2015. One of the best performances for the company during a terrible year for commodities. Issued a "CEO Challenge" in 2015 to reduce costs by 1% ($13.4 million). Managed to cut costs by $15 million. The target for cutting costs in 2016 has been raised to $17 million. Consumption of aluminum is slated to grow by 6% globally in 2016. Additionally, the automobile aluminum supercycle is in its infant stages, with RELY positioned to be a significant supplier in the automobile space. Only 30% of the companies revenues are unhedged. The remaining revenues come from either tolling or are hedged. Free cash flow machine that has allowed for a $50 million reduction in debt in 2015. The company possesses some $900 million in NOLs that haven't been tapped into as of this date. It has been stated that Aleris is not the platform to utilize the NOLs due to significant depreciation expenses. The company is looking for bolt on acquisition candidates, passing on a myriad of deals in 2015 because they did not meet the company's requirements. Management is committed to making accretive future acquisitions while preserving ownership for current equity holders. In other words, very little future dilution. A strong movement taking place in government towards import tariffs...
JUNE CLIENT LETTER: FAILURE GENERATION; HEADLINE GAMES; THE SPORT OF INVALIDS
What follows is a section from the “Thoughts & Analysis” portion of my monthly letter to investors at T11 Capital. The Failure Generation In no uncertain terms, we have been challenged extensively during the first half of 2016. Challenged as to the level of conviction in future economic prosperity. Challenged as to the level of faith in government to govern properly. Challenged as to the level of confidence in the financial markets. Challenged as to the degree of research into our tidy portfolio of three core holdings that have basically floundered in 2016. These challenges are being exasperated by a seemingly perpetual modern infatuation with failure. Everyone from media outlets to prominent billionaires to overly-sensitive millennials are gripped by a near obsession with failure. Economic failure. Individual failure. Corporate failure. Governmental failure. If there is failure to be had, it peaks the interest of all classes of individuals. Take for example the recent army of billionaires who have come out to proclaim imminent doom in the global economy and financial markets. It used to be that billionaires kept enlightened opinions to themselves as the biggest threat to a billionaire is another billionaire. Therefore, by disseminating enlightened knowledge they are only allowing the meager millionaire class to move into the billionaire status creating a form of self-cannibalization to a certain degree. Not in today's world, however. Billionaires are only too eager to tell us all how peasantry awaits any individual who trusts in the global economy to provide any form of prosperity going forward. Soros, Druckenmiller, Rogers, Icahn, Bass and Grantham to name a few. And those billionaires that aren't delivering news of imminent doom directly delegate the responsibility to messengers who tell us they have sat in a room full of billionaires who profess total allegiance to cash in fear of economic collapse. The failure generation has spoken most recently with the surprise vote for Britain to exit the EU. This time they have not simply expressed failure, but have voted for it, in the form of a long standing union failing to exist in its current form. The EU has failed, during a time when, not surprisingly, failure is not only the path of least resistance, but subconsciously, or perhaps even consciously, has become the path of greatest desire. When billionaires aren't discussing publicly the storyline of impending economic failure or citizens voting for the failure of a union, then individuals pass their time by openly and viciously hoping for the failure of the innovators among us. Nobody encapsulates “innovator” better than Elon Musk. Not surprisingly, he is the most derided individual in corporate America, with a...