AUGUST CLIENT LETTER: EVACUATION STATION, DECISIONS OR A LACK THEREOF
What follows is a section from the “Thoughts & Analysis” portion of my monthly letter to investors at T11 Capital. Evacuation Station Equities have experienced nothing less than absolute evacuation during the month of August. The intolerance of individual and institutional investors for increased volatility and risk is abundantly apparent as memories of past crisis situations incinerating capital are still fresh in the mind of many. It has been quite sometime since I have witnessed such a symphony of fear as measured by various indicators and surveys. Here is a brief list along with the appropriate matching illustration: 1. Inflows into money market funds are skyrocketing. 2. Flows out of equities have been massive during August. This has been the largest 5 day outflow in 15 years. 3. Investor exposure to U.S. equities has only twice been lower in the past eight years according to Bank of America. 4. This according to Bespoke: “Following this week’s decline, bullish sentiment has now been below its bull market average of 38.1% for 21 straight weeks, which is the longest streak of the entire bull market. Taking a longer term look, bullish sentiment has been below 40% for 25 straight weeks now. We haven’t seen that long of a streak since August of 1994! “ https://www.bespokepremium.com/think-big-blog/bullish-sentiment-back-on-the-decline/ 5. The put/call ratio has now recorded the most bearish reading of this entire bull market to date as expressed by the 2 & 5 day moving averages of the ratio. What we have experienced is a wholesale evacuation of stocks into illiquid trading conditions brought about by late summer disinterest. A vicious cycle, if you will, of self-fulfilling despondency that is more based upon nightmares of past investor experiences than any semblance of economic reality. What this means for investors is very simply opportunity. Contrarian theory works exceedingly well during secular bull markets, both in terms of predicting points in fear that deserve additional allocation AND points of greed that require the raising of cash in a portfolio. To date we have experienced numerous points of excessive fear, with August being the most substantial example. We have, however, been reluctant to witness any real greed driven, speculative excess as is the hallmark of true market tops. Given the rapidity with which investors are prone to terror, it may be some years yet before we experience such excesses in greed warranting any...
5 CHARTS REVEALING THE HOW AND WHY OF A RALLY TO NEW HIGHS INTO YEAR END
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SO THIS IS NOT THE BEGINNING OF A BEAR MARKET
With that said, the astute investor will be looking for points to put capital to work. There are two support areas ahead that will tell us the scale of malicious intent brought forth by this current correction. I outlined the support areas for both the Dow and Nasdaq 100 in this weekend's review, but thought that it needed to be articulated further. Let's look at Nasdaq 100 first. As I write this note, Dow futures are down over 100 points. If this trend down continues to the market open we should see a gap down below the red trajectory highlighted in the chart below. The ideal situation at that point would be for a steep reversal to take place, closing above the trajectory. Basically, stock market bulls don't want to see a close below 4,150 on the NDX. click chart to enlarge Should the NDX give way, the next obvious and absolutely critical point of support becomes Dow 16,000. And not simply because it's an attractive round number. It carries with it one of the key trajectory points for this bull market. The trajectory goes back all the way into the 1920s, carrying with it a great deal of weight. A touch of this trajectory, followed by a steep reversal back up would be as bullish an indicator for a fall rally as anything. A convincing thrust down below this trajectory sets the markets up for another 7-8 percent on the downside. So 16,000 on the Dow is a big deal. There are a ton of sentiment indicators out there that are flashing some pretty extreme readings. However, it should be noted that steep declines in the markets do occur on extreme bearish sentiment paired with oversold readings, as we have now. In fact, the August 2011 pullback caused by the Euro crisis occurred with extreme bearish sentiment paired with oversold conditions. That one didn't put in its final bottom until October. If catching market bottoms was as simple as buying whenever the put/call reached X number or AAII bullish sentiment went below X, then 95% of hedge funds wouldn't be underperforming their benchmark over the past few years. This is art, not science. ...
4 CHARTS DEMONSTRATING BOTH DESPONDENCY AND HOPE FOR THE WEEK AHEAD
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JULY CLIENT LETTER: BLURRED LINES, THE ART OF SAYING NO, THE MACRO
What follows is a section from the “Thoughts & Analysis” portion of my monthly letter to investors at T11 Capital. Blurred Lines The line between trading and investing is an often debated element of successful methodology within a portfolio. There are some who consistently blur the line, which is perfectly acceptable as long as an investor realizes the “why” behind the action. It is only when a market participant cannot identify whether they are a trader or investor due to inconsistencies in their methodology that trouble follows. I have often said that not enough investors embrace simple trading methods that can enhance their performance. Likewise, not enough traders embrace investment philosophies that can also enhance performance over the long-term. Our unsuccessful investment in EMAN highlights the trading and investment hybrid philosophy that has been a key element in overall performance. That philosophy can be summed up as one of being an investor on the upside and being a trader on the downside. It is true that far too many value investors take their investment thesis to heart, which damages overall performance through a stubborn resilience that is based on adhering to fundamental data points that are lagging indicators of earnings or corporate performance. This causes excessive volatility within a portfolio and absolutely atrocious performance during cyclical or secular bear markets. Within a bear market scenario, as an example, your typical Ben Graham value investor will suffer drawdowns that are often times irrecoverable. Without a tangible exit or risk-control methodology the valuation proposition increases in attraction as price declines which leads to overexposure in an underperforming asset. This consequently will lead to two eventualities: 1) The investor must wait an inordinate amount of time to achieve profitability 2) The investor in the meanwhile suffers opportunity cost as capital achieves more substantial returns elsewhere. This all occurs because of a value methodology that has no counterbalance other than the intellect of the individual operating the strategy. That intellect, of course, is severely biased and utterly incapable of separating itself from the tenets of the philosophy that are rooted in deceptive fundamental data points. The only counterbalance that I know of to properly peel away often erroneous conclusions of the intellect from an individual is the study of price, which is rooted in trading. Thus, one must be a hybrid trader and investor. When the downside becomes excessive or misbehaves in certain predetermined forms, the trading methodology separates an individual from their intellect, essentially overriding all other considerations but price action. Otherwise, individuals become prone to all matters of erroneous decision making based on data points that we are ill-equipped to decipher during...
PORTFOLIO UPDATE: BACK IN IWSY
Earlier today I announced a re-initiation of our position in IWSY on Twitter. I've had a more than two year history with this name, originally profiling the company during the first half of 2013 when the stock was trading below $1. The original research report from March 2013 is available here. The biggest frustration for investors in IWSY has been the lack of tangible earnings coming to fruition despite numerous announcements of partnerships and test pilots with major corporations and government sponsored entities. What investors don't realize are the inner-workings of the software business as it pertains to biometrics. In speaking with two software engineers over the past few months, they told me that product testing cycles for major corporations and especially government organizations is a multi-year endeavor. This becomes all the more stretched out when you are dealing with a new technology, such as biometrics. And add to that the fact that the technology IWSY is developing will protect sensitive personal and government information, you start getting the picture of why any organization involved in a test pilot of their technology would want to make sure everything is 100% effective before launching an actual program. Once the programs launch, whether in the case of Deutsche Bahn, the major retailer in Mexico (rumored to be Wal-Mart), or the newly announced partnership with Lockheed Martin, the SaaS model that has been implemented flows almost purely to the bottom line. The monthly user fees from just a single major contract instantly transforms the company into a substantial producer of cash flow. CEO Jim Miller has said the company will be cash flow positive by year end. The partnerships the company has assembled over the past few years deserve to be noted: Fujitsu, IBM, Deutsche Telecom, CA, General Dynamics, Lockheed, HP, Microsoft, United Technologies to name a handful. The issues of capitalization to achieve full realization of the company's potential were resolved earlier this year, as the company raised $12 million in a direct convertible preferred offering with largest shareholder Neal Goldman of Goldman Capital Management. Avoiding Wall Street institutions to act as a middle man for the transaction caused a bit of a rebellion by these institutions as they summarily downgraded IWSY following the capital raise. The recent announcement of the Lockheed Martin contract is a substantial development for the company, acting as a conduit for adapting IWSY's technology into Federal Government projects. Here is the key line from that press release: " Lockheed Martin will offer the identity service to the federal government and other customers through its FedRAMP approved government community cloud – SolaS®." There is also the issue of...
JUNE CLIENT LETTER: OBSESSION & A NEAR PERFECT MARKET
What follows is a section from the “Thoughts & Analysis” portion of my monthly letter to investors at T11 Capital. Obsession An obsession with endings is something deeply rooted in human psychology. We fear endings to such a great degree that we forget to recognize what is occurring here and now. The fear creates an impetus to agonize, slowly dissolving into a misery-inducing, melancholy study of psychological frailty and worry. The fear of a relationship ending. The fear of a prosperous period coming to a close. The fear of health suddenly disappearing. But most of all, the fear of death. The ultimate ending, I suppose. Reluctance to participate in a bull market because it will one day end is akin to not getting out of bed in the morning because one day you will die. There is a whole generation of current investors who are refusing to get out of bed because they see death as being the inevitable destination of the current march upwards. Much as the man who refuses to get out of bed because of the inevitability of life ending, investors who refuse to participate in the current bull market are missing out on all the creation occurring around them. The fact that investors have been scorned with great repetition over the past 15 years has created a psychological aversion with respect to equities to the point where the specter of an eventual ending supersedes the benefits gained in the meantime. That aversion shows no signs of abating as the ever faithful long-term moving average of the put/call ratio is just now beginning to drop off of 3 year highs. Meaning that investors, as a whole, have been prone to put buying in order to either hedge their portfolios or outright speculation on the downside at a pace not seen in 3 years. Then there is the AAII survey which seems to be populated with investors who prefer not to get out of bed in the morning. AAII is a survey of investor opinion about the direction of the stock market and economy. In a recent June survey, investor's bullish sentiment remained below the historical average of 30% for a seventh consecutive week. You have to go back 12 years to January-February of 2003 to find a similar stretch. But you know what the difference was between January-February of 2003 and now? In the 3 years prior from 2000-2003 the S&P 500 had fallen 39%. Investors had every right to be bearish. Their hopes of Pets.com and JDS Uniphase providing for retirement in Bordeaux, France had been replaced with the reality of having their jet-skis repossessed while worrying...
5 CHARTS DEMONSTRATING A MARKET THAT IS GETTING READY TO RIP DURING THE SECOND HALF OF THE YEAR
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MAY CLIENT LETTER: ACKMAN IS BRILLIANT & LEVERAGING YEAR TO DATE PERFORMANCE
What follows is a section from the “Thoughts & Analysis” portion of my monthly letter to investors at T11 Capital. Ackman Is Brilliant Research on Wall Street has effectively become commoditized. Analysts and portfolio managers bring very little in the way of originality. In fact, a majority of hedge funds are simply platforms built to emulate one another through strategies that employ capital on a copycat basis. The research that is performed at the institutional level uses the same information, derived from the same sources to build the same models that are taught in the same business schools. And when investors in these funds do not receive the returns represented by this menagerie of mediocrity, they blame everyone but themselves. Never have investors stopped to think about how a group as a whole can outperform the markets when their methods, analysis and employees are all linear thinkers, schooled in linear thinking, operating within a completely nonlinear environment. That is why when an idea comes up from a well established fund manager that is both original and thought provoking in nature, it should be discussed. Bill Ackman at the Sohn Conference in May gave a presentation regarding platform companies. Platform companies are essentially shell companies that act as a platform for future acquisitions. Ackman argues that Wall Street cannot accurately value these companies. In fact, Wall Street undervalues these platforms on a consistent basis. When the intangible nature of future acquisitions takes precedent over current earnings, then Wall Street simply ignores the opportunity because it cannot be modeled or simplified through a traditional multiple of earnings approach. Instead, as Bill Ackman points out in his presentation," investors must value the company based on both the earnings potential of the company's current asset base, as well as the potential to generate additional earnings through future, value enhancing investments. " This line of thinking delves into the non-linear realm of securities analysis that isn't taught at business school. It involves abstract concepts and probability that are more entrepreneurial in nature. In other words, it's the type of concept that causes smoke to begin funneling out of your typical analysts ears, with the eventual outcome being a complete cessation of brain activity. When a corporation cannot be easily analyzed then inherently there will be inefficiencies in pricing that asset. Whenever an investment is dominated by abstract, non-linear business concepts, then the markets have no choice but to either a) ignore or b) sell. There is rarely, if ever, a premium given to such a situation. The inefficiencies become all the more pronounced once an investor decides to move into subsets of the market, such...