My Best Relative Value Week in a Long Time

I’ve worked for years to take the emotions out of my investment processes, with some success.  Where it gets tough is when I am in an absolute and relative drawdown, as I was for most of the second half of 2007.  Nonetheless, I stuck with my disciplines.  This week, a lot of things went right:

  • Retail
  • Insurance
  • Trucking
  • Energy
  • Small cap value was the best style

Will this persist?  Who can tell…  I was ahead of the Russell 2000 Value index this week, even though my portfolio is more midcap value in nature.  I’m still wrestling with where to deploy incremental funds.  I’m 2-3 positions light at present, and I know I am already insurance-heavy, with many of my best candidates being insurers, and the rest Irish Banks.  I don’t want to get too heavy in financials… I’m overweight there now.  Ideas are welcome.  Oh, at the end of the day I did make a small purchase:


David Merkel
Rebalancing Buy
1/25/2008 4:02 PM EST

Bought some Gruma, SA into the close. Tortillas and other Mexican foods are not going out of style, even if the Mexican stock markets are having difficulty of late. I’ve had a good week. Hope you did too.

Position: long GMK

The market always has a new way to make a fool out of you, so I am not relying on a change in the financial weather here.  I just keep doing what I do best.

Full disclosure: long GMK

2 Comments

  • James Dailey says:

    Hello David,

    I know you are more of an investor than a trader, but I would be cautious about your relative strength. If this is a bear market rally, and I think it is, it is normal for the weakest areas of the market to lead to the upside. Personally, I am playing those areas for a trade – particularly retail and financials. However, it seems to me that your portfolio is very underweight defensive growth like healthcare and staples. Those are looking really weak on a relative basis this week and I think they are a good relative opportunity. I play more at the sector level than the stock level, but I think PFE and JNJ are very good values. The XLV is an obvious proxy for the sector. I also like the XBI – an equal weight biotech ETF. I think the equal weight is critical, as individual companies blow up in that sector all the time and if it is heavy weighting (see AMGN and DNA impact in the BBH and IBB).

    I think Annaly Capital management is a great opportunity off the price weakness following Thursay’s secondary. Management has a great track record of only raising equity when they can put it to work in an immediately accretive fashion. I would expect the dividend to head towards $.50 per quarter this year and the stock could move into the mid $20’s, as the company is very well positioned to take advantage of the mortgage unwind.

    One long term micro cap I really like is MLR. I bought the stock at distressed levels in February 2003 and sold a bit early during the post Katrina spike in the low $20’s. The stock is around $12. It is a great little business with big market share in tow trucks/wreckers. The management team suffered through a liquidity crisis from 2001-2003 and have been ultra conservative managing the balance sheet since. There is very little debt and the company used the cyclical upswing to upgrade/modernize their P/E. I have followed the company for about 10 years and believe mid cycle earnings are in the $2 – $2.50 area. Cost pressures suppressed margins this past cycle and they stayed in the 13-15% range vs the historical peak earnings cycle level approaching 20%. If they can approach high teens operating margins in the next cycle, I think peak earnings could be close to $4. I think the stock is likely to head back to the $30-$40 range next cycle – though patience will be required!

    On the purely spec side, US Gold is run by Rob McEwan – former CEO of Goldcorp. Rob is the single best sharehold-friendly mining exec in the world, in my opinion. UGX is purely at the exploratory stage, so risks are immense. However, if there is one guy I would be willing to place a bet with it is McEwan. Also, I think it is possible/likely that the precious metals sector will enter a much more speculative phase. Any success in exploration could drive a very compelling story for the stock in a more speculative gold market. Junior miners have performed horribly the past 2 years – hardly a sign of a speculative gold market. Even gold bugs like Bill Fleckenstein and Fred Hickey have no or relatively low exposure to miners, as their performance has driven many to become GLD/bullion players primarily.

    Finally, I haven’t seen you post about hedging at all in the past, but I think that the emerging markets are setting up as an excellent “bang for the buck” hedging tool. I personally have a target of the SPX rallying about 5-7% more during this rally (assuming it is of the bear market variety) and think the EEV is a great option to buy at that point. I have an eventual target for the EEV at about $121 and expect to buy it back in the mid $70’s.

    Full disclosure – my family owns PFE, JNJ, XLV, MLR and NLY and NLY.A and sold EEV Wednesday last week.

    Finally, I would really enjoy an explanation as to why you sold RWT – seems to me they weathered the storm quite intact and are positioned to take advantage of the dislocations in the mortgage market. I thought about buying it when it hit $32 last week but I’ve been shy because of the relative illiquidity in the stock.

    I suspect that with all of these, at least one will do well so that I can claim victory! Good luck.

  • James Dailey says:

    Sorry – US Gold is UXG and my family also owns a position in the stock.