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...
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...
5 CHARTS REVEALING THE DIARY OF AN ODD MARKET
By no means should this current market be considered sane. In fact, it is quite odd. It is odd because following a relatively strong year for the major averages in 2014, January is off to a completely nauseating start. According to well substantiated Wall Street lore, January is supposed to be a time of minting money following strong performance in the previous year. If January continues at its current pace, it will mark the second year in a row that Wall Street has been thrown a screw ball instead of a slow pitch in January. While last year's malfeasance during the month proved to be benign in nature, there is a substantial possibility that this January has much more nefarious intentions in mind. Allow me to demonstrate via the following 5 charts: click chart to...
NEWEST RESEARCH REPORT: 15 PAGES ON IMH (IMPAC MORTGAGE)
T11 Capital Management is currently long IMH at prices between 5.50-6.50. Download (PDF, Unknown)...
CLIENT LETTER: A MARKET OF ABUNDANTLY FAVORABLE ODDS
What follows is a portion from the monthly client letter I send out to investors. A Marathon, Not a Sprint In the spirit of welcoming the new year with a sense of forthrightness that seems to be lacking on Wall Street, I found the second half of 2014 to be agonizing. Perhaps my agony stems from the fact that I was caught in the malaise that was small-cap trading during this period. Or maybe it lies in the fact that the major benchmarks just kept going up while I couldn't figure out which names were driving the market forward. In any case, the narrow market of 2014 left all but a chosen few scratching their heads wondering out loud, “what can I do to keep up?” Although yearly performance is an important statistic that I take pride in, all investors are prone to forget the fact that this is marathon, not a sprint. There is no strategy that can be asked to outperform under all market conditions. Within any strategy there are times that a digestion period takes place. The investments within a portfolio don't know or pay attention to the same calendar you and I do. They are driven by events, both macro and micro, that are sometimes immediately reflected in the stock price and other times take many months to be realized. In either case, patience is the determining factor as to who ends up successful and who ends up in misery. The Antithesis of Euphoria Why exactly were small-cap companies such underperformers in 2014? The broad stroke version of the answer lies in the fact that small-cap names required a break. They had been moving at breakneck speeds over the past few years, with double digit up years every year since the 2009 bottom with the exception of 2011. In fact, the preceding year (2013) was the strongest year of all with a gain of near 40% for the Russell. So it turns out to be a well deserved break, in fact. The most pressing question, at this point, is how can a market be in any type of euphoric stage when entire swaths of speculative sectors, whether small-cap or otherwise, are left for dead in the midst of a narrow advance? If anything, this reveals a market that is timid in nature, as a small group of well heeled, sophisticated investors bid up companies that are well-researched, extremely liquid and fairly reliable with respect to earnings. This is the antithesis of euphoria as it demonstrates responsibility in the face of increasingly frequent record highs in major indices. Euphoric markets are characterized by...
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...
5 CHARTS SHOWING WHY A SYMMETRICAL MARKET IS A HEALTHY MARKET
The following charts demonstrate how symmetrical this market remains. A symmetrical market is generally a healthy market. It is only when symmetry begins to break down and chaotic price movement becomes the norm that significant reversals take place. click chart to...