• On Paradigm Shifts http://t.co/h68quEDX Hunter takes us through mental exercises 2 make us intelligently contrarian. “Invert, Always Invert” May 02, 2012
• Hedgers’ net short position vanishes in US oil http://t.co/X0hLOWGB Commercial interests do not fear lower prices, could be bullish 4 crude May 02, 2012
• There’s Plenty of Money for Junk http://t.co/vXML0Bao Presently the credit cycle is virtuous; vicious part is coming, but no appt set $$ May 02, 2012
• Bad Models Mistook Housing Bust for Dot-Com Bubble http://t.co/IxC8m2mk Busts of assets that are heavily levered harder than unlevered $$ May 02, 2012
• Best U.S. Real Estate With Self-Storage http://t.co/mxyHdK2U Self storage a winner in the past, may not do so well in the future; hi vals May 02, 2012
• Marginal oil production costs are heading towards $100/barrel http://t.co/G2zNB5JS Same as my reasoning on high crude prices $$ May 02, 2012
• Four-percent rule a relic, advisers say http://t.co/PrdHQy48 Better rule: 10y Tsy yield plus 0% if bearish, 1% if neutral, 2% if bullish $$ May 01, 2012
• The remarkable resurgence in synthetic credit tranches http://t.co/1iIZ8ous Increases in the notional amounts of several corp bond swaps May 01, 2012
• Contra: Black Scholes & the formula of doom http://t.co/flVNsYMx Debt levels & Asset-Liab mismatch largest causes of crisis not BS model Apr 30, 2012
• Energy’s Pain is Consumer Discretionary’s Gain http://t.co/lM7UW0T7 I have been on the wrong side of this trade. Sigh. $$ Apr 30, 2012
• Notes from the DoubleLine Lunch with Jeffrey Gundlach, Spring 2012 http://t.co/KDiqA5Sp Gives a good overview, w/a large topping of snark $$ Apr 30, 2012

China

• China’s Auditing Train Wreck http://t.co/UeIZtw06 Any Chinese firm listed in the US, the auditors should be subject to SEC scrutiny. $$ May 05, 2012
• China bear Pettis says world coming around to his view http://t.co/lo1nGc7e Pettis isn’t a bear but a realist; invt-led growth overplayd $$ May 04, 2012
• The Family and Corruption http://t.co/R4NwZ6od Family ties & group affiliation dominate economic/political power among Chinese Communists $$ May 04, 2012
• Who is Fu? Chinese exile is ‘God’s double agent’ http://t.co/plyQhwtg Story of a Chinese Pastor in US & escape of Chen Guangcheng $$ May 02, 2012
• Microblogs Survive Real-Name Rules–So Far http://t.co/5UItJjwj Even the CCP would have a hard time shutting down their Twitter-apps $$ May 02, 2012
• Beijing’s secret: It’s not really loosening http://t.co/3RPhAOwH There is not enough demand in China 2 pay all of the high prices. $$ May 02, 2012
• China’s Left Behind Children http://t.co/OL0gmSFE Economic growth that separates parents from children imposes significant costs on China $$ May 02, 2012
• China Closes Unirule Website http://t.co/ItkW0p0A Founder receives award from Cato Institute; China government shuts down his website $$ May 02, 2012
• China’s property boom has peaked, forever http://t.co/aLC2U8F8 Amount of deadweight in China property is so large that prices have peaked $$ Apr 29, 2012

Financial Services

• Caution: Contents May Be Hot http://t.co/cp9yjbH3 I worry about ETF slippage from bad creation/redemption unit design & bad trading by users May 04, 2012
• Well, That Was Awkward… http://t.co/zS5f6zAI Bank Chiefs’ Regulatory Concerns Met With Official Silence; maybe regulators getting fed up May 04, 2012
• A talent shortage looms as the industry booms http://t.co/QGLZzzg7 Financial planners getting old/retiring faster than the Baby Boomers $$ May 04, 2012
• 2nd attempt2 automate bond trading 1st failed RT @BloombergNews: Goldman preps trading system for corporate bonds | http://t.co/NceasmN7 May 04, 2012
• Mortgage Rates in US for 30-Year Loans Fall to Record Low http://t.co/LPolAP5Q Mtge rates b nimble, MR b quick, MR go under limbo stick $$ May 04, 2012
• Spending A Year On An M&A Bidding War Is Apparently Overrated http://t.co/tKguPYGy It’s well-known that scale acquirers underperform $$ May 04, 2012
• Every liability has an asset, but not every asset has a liability. Some are owned outright. http://t.co/fB3ARju7 May 03, 2012
• Canadians Dominate World’s 10 Strongest Banks http://t.co/qj6TOgA3 Ask again after their housing bubble pops, same 4 other fringe nations May 03, 2012
• Pimco’s latest ETF shields against price spikes http://t.co/TmOrCIj2 I wonder if active ETFs will have more performance slippage. $$ May 02, 2012
• Hedge Funds Hurt by Volatility http://t.co/ogoL62qT Hedge funds r vehicles that do better when credit spreads r tightening $$ May 01, 2012
• Bond Market Is Creating A New Galaxy for Trading http://t.co/YgvNwz1j Dealer inventories thin; trading costs rise; electronic mkts start May 01, 2012
• US banks still cutting commercial real estate exposure http://t.co/qsqIMRph Banks still rotating out @ an almost constant rate since 2009 $$ Apr 30, 2012
• Largest U.S. Banks Resist Federal Reserve’s Credit Limits http://t.co/JndcrvWI Big banks need 2b broken up or shrunk; they don’t accept it Apr 29, 2012

US Fiscal/Regulatory Policy

• CEOs rank Texas tops for business, California worst http://t.co/jWEIGP89 8th year in a row for this survey; high taxes/regs annoy CEOs $$ May 04, 2012
• Exposing the Medicare Double Count http://t.co/HIVIx3lJ Same $$ being spent twice, must borrow the difference. May 02, 2012
• Coburn: `We Ought to Totally Revamp Our Tax Code’ http://t.co/71WquMIf Very similar to my proposals; simplify code eliminate deductions $$ May 02, 2012
• U.S. Considers Notes That Float http://t.co/jynXGcYG Intermediate-dated Tsy floaters would trade above par, neg yields like TIPS $$ May 01, 2012
• Trying to Shed Student Debt http://t.co/0GmvckOn Lawmakers Rethink Bankruptcy-Law Ban on Walking Away From Education Loans $$ #slavery Apr 30, 2012
• Can the US Economy Recover Without a Housing Recovery? http://t.co/Tqy4l8J3 It will probably have to try w/o housing’s assistance $$ Apr 30, 2012
• Central Bank paper suggests house prices have ‘over-corrected’ http://t.co/KDrXCkzy Have Irish housing prices overshot? Tough 2 say. $$ Apr 30, 2012
• http://t.co/KbnUO93s Treasury floaters could b issued @ premium 2 par 2 inflation speculators allowing the Tsy 2 finance @ negative rates Apr 30, 2012
• U.S. Perfecting Formula for Budget Failure, Says Bowles http://t.co/vlLQzZ8q It’s nice 2b a part of a nation that is a global leader $$ Apr 30, 2012
• Will TARP Make a Profit? That’s the Wrong Question http://t.co/MZBHaO51 Conflicting govt goals make policy hard 2 implement & interpret $$ Apr 30, 2012
• You will buy more Govvies, or else http://t.co/DLrnyb9u Financial Repression, Quantitative Easing, Debt Monetization, Hyperinflation $$ Apr 30, 2012
• On Student Loans, Accounting Gimmicks, Electric Cars, FX and a note on SS http://t.co/2BCB9nAi Hodgepodge of insight from @brucekrasting $$ Apr 30, 2012
• “The Treasury should be issuing 100 year or perpetual bonds until the market can’t stand it anymore to lock in these … http://t.co/gXMUXW4C Apr 30, 2012
• The floating YTMs will probably be negative, as interest rate speculators will pay more than par for the floating rat… http://t.co/OSmE7QuJ Apr 30, 2012

Eurozone

• The euro crisis just got a whole lot worse http://t.co/XSqmQnGv Election of Hollande may lead2 Euozone policy paralysis; growth v austerity May 04, 2012
• Making eurozonians, or not http://t.co/JmuO5OXC The Eurozone was never a natural place to set up a shared currency. $$ May 04, 2012
• Madness in Spain Lingers as Ireland Chases Recovery http://t.co/BXdYSX5e Ireland may b rebounding, as Spain’s slump deepens #austerity $$ May 02, 2012
• Why the New York Times’s Paul Krugman is clueless about the European economic crisis http://t.co/xMuzZXC7 Aside frm Ireland no austerity yet May 02, 2012
• Core infection and eurozone PMIs http://t.co/xr97yPgD Core of the EZone sluggish @ a time when it can least afford it $$ #depressionary May 02, 2012
• ECB Measures Pushing Domestic Bonds Into Domestic Banks, Planting Seeds for Euro Disintegration http://t.co/HAITJJnX Yeh, this da future $$ May 02, 2012
• The rise in the Eurozone money supply has not improved credit conditions http://t.co/rYazqcuP Euro M3 diverges from bank loans $$ May 01, 2012
• The ECB lending to periphery governments via “backdoor SMP” http://t.co/uQeG2QQK How to stuff the ECB full of Eurofringe debt, c/o LTRO $$ May 01, 2012

Rest of the World

• Brazil: cutting at any cost? http://t.co/mh3vN1Te Pushes up asset & price inflation, as currency held down 2aid exporters; unsustainable $$ May 04, 2012
• Turkey Credit Rating Outlook Cut by S&P on Worsening Trade http://t.co/pFDzEhZl Wide current account def & hi external financing needs $$ May 02, 2012
• Once poster child of crisis, Iceland recovers http://t.co/Sgr2wTGl Letting banks fail & stiffing foreign creditors -> winning solution $$ May 02, 2012
• Which emerging economies are at greatest risk of overheating? http://t.co/olHdiYRE A gauge from the Economist on which Em Mkts r2 hot $$ Apr 29, 2012

Company News

• Buffett’s CTB Adds Chicken Eviscerators in Dutch Purchase http://t.co/K6Q3NGt2 Buffett’s firm is no chicken; it has a lot of guts! $$ May 04, 2012
• Sorry, really sorry… May 04, 2012
• Ackman Rejects Canadian Pacific Deal Ruling Out CEO Pick http://t.co/KYe970NJ Pick is former CEO of $CP rival $CNI – Bad blood; good CEO May 02, 2012
• Impressive work Mr. Einhorn. The analyst that wrote up the question deserves praise; if you did that… http://t.co/tSTWxqBa May 01, 2012
• Phillips 66 aims to run more shale oil http://t.co/tC7NBfLO LD: + $COP $PSX First day of trading for the new $PSX. Combo up 2%+ so far $$ May 01, 2012
• Value investing does not mean cheap. It means margin of safety. Cemex does not have that. Look at the debt. $CX $$ http://t.co/ydklVkth May 01, 2012
• Falcone Agrees To Step Aside http://t.co/bYgLxMMV “a final agreement may not be reached, and a bankruptcy filing was still possible” $$ Apr 30, 2012
• Delta to buy US refinery for $150 million http://t.co/IsK9xsDu If zero is dumb & 100 is very dumb, this one scores in the 90s. $$ Apr 30, 2012
• Discuss “At $1.7 billion, Nook is worth more than Barnes http://t.co/xOz6skwP Spin off Nook 2 create value $$ $BKS $AMZN #interneteatsbooks Apr 30, 2012
• @ampressman Would it have been value-enhancing to $BKS 2 sell the whole Nook unit 2 $MSFT, in your opinion? $$ Apr 30, 2012

Statistical Analysis

• trading-and-the-null-hypothesis http://t.co/QpYutOTb Problem:No academic journal wants2 publish studies with ‘no result’ as their conclusion May 04, 2012
• . @thenumb47 Allows for too much of a specification search; would be good to require disclosure of everything tried but not published $$ May 03, 2012
• Have to allow for accidents! RT @incakolanews: just scrub the word “validate” and I think you have a great idea May 03, 2012
• Thus my proposal for economists: come up w/research idea: goes 2a database. Randomly assigned economist will analyze & trash/validate it $$ May 03, 2012
• Unlike double-blind studies, raw statistical research allows health analysts to inject their own bias into the analysis, as economists do $$ May 03, 2012
• Analytical Trend Troubles Scientists http://t.co/bzcAIpHG Health researchers using statistics like economists find ambiguous results $$ May 03, 2012

Miscellaneous

• 14 Lessons From Benjamin Franklin About Getting What You Want In Life http://t.co/BWAjCz1l Advice from 1 of the wealthiest men of America $$ May 04, 2012
• Is Wall Street Meeting God’s Expectations? http://t.co/5H5j2QGG Many Christians misuse the Bible; almost all non-Christians misuse it $$ May 03, 2012
• What would Jesus trade? http://t.co/Dkrfwt9k Many Christians misuse the Bible; almost all non-Christians misuse it; another example $$ May 03, 2012
• And in a more honest way than Google RT @SconsetCapital: Long good, short evil. May 03, 2012
• Apparel-Swapping Millennials Eschew Stores and Malls http://t.co/B7jq2dcY “Is that a new outfit?” “Well, it’s new to me!” An odd trend $$ May 03, 2012
• @TheStalwart Kasriel was different enough that he will be missed, kind of like the sound of one hand clapping $$ #littledoghasbuddhanature May 01, 2012
• The record 4 tallest bldg s/b based on weighted average height; weighting based on cross-sectional area @ height http://t.co/03HNZ0BB $$ Apr 30, 2012
• So if you have something thin at the top, it wouldn’t count 4 much. A rectangular parallpiped would get full credit 4 height $$ #usingmath Apr 30, 2012
• That would work, simpler than mine $$ RT @Pollack7: @AlephBlog Meh.Highest continuous occupancy floor. Apr 30, 2012
• As the smartest boss I ever had said “Make bets, but never bet the franchise.” http://t.co/qWdHX3BS Apr 30, 2012

Monetary Policy

• Bernanke Charts New Mission For Fed: Financial Stability http://t.co/6RrWEQws Fed has a hard enuf time w/a double mandate, triple will b wrs May 02, 2012
• Then again, if focusing on financial stability forces the Fed to be more restrained in its monetary policy, that would be good. $$ May 02, 2012
• Bernanke: Be Humble! http://t.co/6icSHD1K The picture says it: http://t.co/OqOflqsI Humility in BB’s view: leaving monetary policy loose $$ May 01, 2012
• My Speech Delivered at the New York Federal Reserve Bank http://t.co/DbAhOdQR An Austrian let loose amid the marble palace in NYC?! Wow. $$ Apr 29, 2012

US Politics

• Renewed Hope that Jon Corzine, President Obama’s Top Tier Campaign Bundler, Will Face Criminal Charges http://t.co/wCLrXFve J. Tavakoli $$ May 01, 2012
• Occupy Wall Street Plans Global Protests in Resurgence http://t.co/0FLjKfiJ #OWS won’t b effective until they organize as a 3rd party $$ + May 01, 2012
• Or, organize to influence the Democrats the way the t-party does the Republicans. #OWS is irrelevant until then, b/c it doesn’t do anything May 01, 2012
• Is that a bailout in your pocket? http://t.co/8xwW4Cbi Boyazny, panel’s populist, replied that the credit markets had become “undemocratic” May 01, 2012

Now fewer companies have analysts following them, and the database that I use is not as reliable on earnings estimates for foreign companies trading on US exchanges.  The following table covers a huge percentage (98%+) of the market cap of domestic stocks trading in the US.

Definitions:

• FE Yield: forward earnings yield for the next full 12 fiscal months.
• E Yield: trailing earnings yield for the last twelve months.
• D Yield: dividend yield given the current price.
• F Payout %: what percentage of the next fiscal year’s earnings is comprised by dividends.
• E Growth: how much do the estimated earnings of the next fiscal year increase over the earnings of the last 12 months.

And here it is by sectors:

Some of the percentages for earnings growth are inflated because the last 12 months include writeoffs, disappointments, etc., but forecasted earnings are typically optimistic, and anticipate no errors.

I would encourage you to view this where you look down the list, and say, “Wait. That doesn’t look right. That industry shouldn’t be that high/low relative to other industries.”  Then dig in and try to analyze for individual companies where there might be real advantage in the industries with good relative prospects.

Being forward-looking is an advantage if you have an ability to discern where industry trends are going to change; I may have that to some small degree, which is why when I invest, I look at trailing earnings and forward earnings.  Have one foot in reality, and the other foot in hope/analysis.  Things change less than expected, but things change.

As for me, I’m happy with my energy, insurance, and technology stocks, even if I haven’t been rewarded well over the last three months.  They are cheap, and have decent pricing power.  I stress patience, and so I hold after poor results, and I might increase the stakes.

Here are the earnings yields, dividend yields, and payout ratios (what percentage of trailing 12-month earnings have been paid out as dividends) by industry and sector:

Now, remember that the earnings yields here are backward-looking.  To give you an example, property-casualty insurers and reinsurers lost a lot over the last 12 months, but still managed to have P/E ratios of around 18 (5.5% earnings yield).  When you look at these tables, ask yourself how good current prospects might be relative to the last 12 months.

Also remember that cyclical companies tend to have low valuations before their sales slump.  As sectors go, I think Energy has a lot to commend it in this environment.  Could have a lot of upside, and not much downside.

The tables above cover the whole market, 8800+ companies weighted by their market capitalizations.  I could do a second version to these tables for a subset of the markets, forward-looking, which used the earnings estimates of the sell-side.  I suspect that would cover the larger half of the companies, and roughly 99% of the total market cap.  Let me know if you would like that, it wouldn’t be that hard to do.

PS — Note that everything here is in line with the terms of my data license, because every number here is one that I calculated.  I try to follow that rule in things that I publish, aside from well-known and limited bits of data.

I’m working on my quarterly reshaping — where I choose new companies to enter my portfolio.  The first part of this is industry analysis.

My main industry model is illustrated in the graphic.  Green industries are cold.  Red industries are hot.  If you like to play momentum, look at the red zone, and ask the question, “Where are trends under-discounted?”  Price momentum tends to persist, but look for areas where it might be even better in the near term.

If you are a value player, look at the green zone, and ask where trends are over-discounted.  Yes, things are bad, but are they all that bad?  Perhaps the is room for mean reversion.

My candidates from both categories are in the column labeled “Dig through.”

If you use any of this, choose what you use off of your own trading style.  If you trade frequently, stay in the red zone.  Trading infrequently, play in the green zone — don’t look for momentum, look for mean reversion.

Whatever you do, be consistent in your methods regarding momentum/mean-reversion, and only change methods if your current method is working well.

Huh?  Why change if things are working well?  I’m not saying to change if things are working well.  I’m saying don’t change if things are working badly.  Price momentum and mean-reversion are cyclical, and we tend to make changes at the worst possible moments, just before the pattern changes.  Maximum pain drives changes for most people, which is why average investors don’t make much money.

Maximum pleasure when things are going right leaves investors fat, dumb, and happy — no one thinks of changing then.  This is why a disciplined approach that forces changes on a portfolio is useful, as I do 3-4 times a year.  It forces me to be bloodless and sell stocks with less potential for those with more potential over the next 1-5 years.

I like some technology names here, some energy some healthcare-related names, P&C Insurance and Reinsurance, particularly those that are strongly capitalized.  I’m not concerned about the healthcare bill; necessary services will be delivered, and healthcare companies will get paid.

A word on banks and REITs: the credit cycle has not been repealed, and there are still issues unresolved from the last cycle — I am not interested there even at present levels.  The modest unwind currently happening in the credit markets, if it expands, would imply significant issues for banks and their “regulators.”

I’m looking for undervalued and stable industries.  I’m not saying that there is always a bull market out there, and I will find it for you.  But there are places that are relatively better, and I have done relatively well in finding them.

At present, I am trying to be defensive.  I don’t have a lot of faith in the market as a whole, so I am biased toward the green zone, looking for mean-reversion, rather than momentum persisting.  The red zone is pretty cyclical at present.  I will be very happy hanging out in dull stocks for a while.

P&C Insurers and Reinsurers Look Cheap

After the heavy disaster year of 2011, P&C insurers and reinsurers look cheap.  Many trade below tangible book, and at single-digit P/Es, which has always been a strong area for me, if the companies are well-capitalized, which they are.

I already own a spread of well-run, inexpensive P&C insurers & reinsurers.  Would I increase the overweight here?  Yes, I might, because I view the group as absolutely cheap; it could make me money even in a down market.  Now, I would do my series of analyses such that I would be happy with the reserving and the investing policies of each insurer, but after that, I would be willing to add to my holdings.

Do your own due diligence on this, because I am often wrong.

But what if valuations get so strained that future returns from most risk assets are tepid?  At that point, buy-and-hold turns into sell-and-wait.  It’s like being a bond manager — if the excess returns are small from taking additional risk, you don’t take additional risk.

I tend to turn over my portfolio once every three years.  That to me is a good tradeoff between holding for a long time and recognizing that opportunity changes over time.  But my trading is driven by analyzing relative opportunity, selling what I think are lower future cash flow streams for larger cash flow streams.  Do I have a crystal ball to tell me which is better?  No, just business judgment.  As Buffett says, “I am a better businessman because I am an investor, and I am a better investor because I am a businessman.”

My business judgment has done well for me over my career, but I don’t pretend that it is infallible, because I make significant mistakes.  Humility is an asset to the investor, because we don’t always know the right course.  That said, let diversification handle uncertainty, and within risky assets trade away less promising assets for those with more promise.

A reader wrote me, one who works for a prestigious university and he said:

Since 1926, the minimum inflation-adjusted total return of the S&P 500 (or its predecessor index) has been over 4%, annualized, over every 40-year rolling period.  For 20-year periods, the returns are typically either high (say 9%) or low (say 2%).  Thus, the buy-and-hold investor is best off with the 4-decade hold time.  Fortunately, 40 years matches the typical work life of a person, so workers ought to be shoveling retirement money into equities, and leaving there when they retire, if history is any guide.

 Your thoughts?

Yes, so long as your government holds together, over longer periods of time we do better.  But the tough part for retirees is “What is my situation like when I retire?  Yes, I built up a pot of assets, but what will that buy in terms of continuing income, and will that do well against declining purchasing power?”

There is no magic bullet.  I try to solve this by shifting industries over time, aiming at the most promising current opportunities, but not leaving the market in entire.  I limit cash to 20% of the portfolio when valuations are strained for he market as a whole.

Back to the question, yes, I think most people should buy-and-hold, if they can’t analyze the asset markets.  That’s like the Biblical proverb that a fool is counted wise if he is silent.  But for businessmen/investors there are often relative opportunities to do better.  Analyze those opportunities and take the best of them.

Yes, have some exposure to risky assets for your career, but vary the amount of exposure, and where it goes relative to likely opportunity.

I appreciated Jonathan Burton’s piece Speed kills, but so does complacency.  Like me, he is trying to strike a balance between hyper-trading and permafrost.

My mother is a good example here, though she does things differently than I do.  She holds stocks for a decade or so on average, and analyzes to see whether they have long-term prospects.   She buys, holds, and occasionally adjusts.  She spends more time painting, for which she has a degree of reputation.  She beats average asset mangers regularly.

The main idea should be one of relative value: trade to improve.  Look at the underlying cash flow streams if you can, and trade smaller for larger.

Here’s one more tool to help you.  When the amount of money into an asset goes parabolic, it time to leave.  It is rare that large amounts of additional money will yield excess returns.  This simply admits that there are times when it is wise to reduce exposure to risky assets.  just as bond managers look at yield spreads to commit capital, so should investors in risky assets aim for a margin of safety in what they invest.

As a final note, buy-and-hold is a fundamental strategy in investing.  It presumes that you spent the time analyzing whether this asset was undervalued.  If it becomes overvalued, it does not mean you should hold it.  Always look for better relative value.  In the end that leads to better portfolio performance.

Truth is, clever investors, or lucky investors can get an attitude, saying that they don’t have to explain themselves to outsiders.    Not a good place to be. I am not saying that the performance is due to luck but there is a certain amount of respect due to investors for investing with you.

Before I write more, let me state that I respect Allan Mecham.  He manages more money than I do, and has a better track record.  If I were in the shoes of the investors who were analyzing him, I probably would have placed $5 million with him, and would have watched what he did carefully.

Why would I take the risk?  It’s tough to find non-consensus views that make significant money.  I wouldn’t want to make it a huge allocation initially, but I would put a toe in the water to see what he would actually do.  If it didn’t work over 5 years, I would pull the plug.

All that said, when you run a very concentrated portfolio, it is possible for a few decisions to drive a lot of performance.  I would feel more confident regarding someone who had made more correct decisions, because it would indicate a higher likelihood of a repeatable process.

Let me give you an example from my own portfolio.  I own SABESP [SBS], one of the largest water utilities in the world, which provides water and other services for the city of Sao Paulo in Brazil.  I got the idea from Cramer.  It’s the only idea I have ever gotten from Cramer and acted on.  I have held it for eight years, and the stock has quintupled.  Beyond that, I have made trading gains, because it has been somewhat volatile, as most Brazilian stocks have been.  And what proportion has this been in my portfolio?  Around 3%.  The largest position in my portfolio over the last 12 years has been 8%, and it has been rare to have a position larger than 4%.

One strength of what I do in asset management is that I don’t force trades.  I’m patient.  I trade 3-4 times a year, swapping out 2-6 companies each time.  The portfolio turns over once every three years.   But that means that roughly one-third of the portfolio I have held more than three years.  It’s not that those companies are old friends, but they continue to survive the tests that I give the whole portfolio.  That said, when I sell one of those held longer, I do feel a slight sense of loss; it’s like losing a close friend.  I know I contradicted myself here, but that’s because my views are ambiguous here.  My summary would be that I love the companies that I have held for a long time, but they have to pass the test 3-4 times a year.  There are no free passes, and no sentimentality.

I know more about my own processes than I do of Mecham’s.  But I have felt the cold appraisals from institutional managers over the last five years, with the implicit complaint — “you have done well, but you don’t manage enough money, so we are not going to invest with you.”  This is the same response as “we don’t buy anything other than IBM.”

I can talk about my own processes until my face turns blue.    They will still work in most environments.  But the article tells a story of investors that are risk-averse, but without any good sense of what true risk is.

For those that are looking for the next great investor, he does not look like the next great investor, but he looks odd, like Buffett did in the 50s and 60s.  Take the chance, and invest with the odd value investor.  Invest with several of them, diversify.

If I were managing assets for a pension fund, I would assemble a stable of new-ish value managers, and that would be 70% of my portfolio, with 30% investment grade bonds.  Boring and beautiful.

Without reviewing Allan’s trades, I can’t say how certain I am of his abilities.  But I would have a bias in favor of small value managers with good track records, particularly those who have been diversified.

Full disclosure: long SBS

Industry-Ranks-2-2012

I’m working on my quarterly reshaping — where I choose new companies to enter my portfolio.  The first part of this is industry analysis.

My main industry model is illustrated in the graphic.  Green industries are cold.  Red industries are hot.  If you like to play momentum, look at the red zone, and ask the question, “Where are trends under-discounted?”  Price momentum tends to persist, but look for areas where it might be even better in the near term.

If you are a value player, look at the green zone, and ask where trends are over-discounted.  Yes, things are bad, but are they all that bad?  Perhaps the is room for mean reversion.

My candidates from both categories are in the column labeled “Dig through.”

If you use any of this, choose what you use off of your own trading style.  If you trade frequently, stay in the red zone.  Trading infrequently, play in the green zone — don’t look for momentum, look for mean reversion.

Whatever you do, be consistent in your methods regarding momentum/mean-reversion, and only change methods if your current method is working well.

Huh?  Why change if things are working well?  I’m not saying to change if things are working well.  I’m saying don’t change if things are working badly.  Price momentum and mean-reversion are cyclical, and we tend to make changes at the worst possible moments, just before the pattern changes.  Maximum pain drives changes for most people, which is why average investors don’t make much money.

Maximum pleasure when things are going right leaves investors fat, dumb, and happy — no one thinks of changing then.  This is why a disciplined approach that forces changes on a portfolio is useful, as I do 3-4 times a year.  It forces me to be bloodless and sell stocks with less potential for those with more potential over the next 1-5 years.

I like some technology names here, some energy some healthcare-related names, P&C Insurance and Reinsurance, particularly those that are strongly capitalized.  I’m not concerned about the healthcare bill; necessary services will be delivered, and healthcare companies will get paid.

A word on banks and REITs: the credit cycle has not been repealed, and there are still issues unresolved from the last cycle — I am not interested there even at present levels.  The modest unwind currently happening in the credit markets, if it expands, would imply significant issues for banks and their “regulators.”

I’m looking for undervalued and stable industries.  I’m not saying that there is always a bull market out there, and I will find it for you.  But there are places that are relatively better, and I have done relatively well in finding them.

At present, I am trying to be defensive.  I don’t have a lot of faith in the market as a whole, so I am biased toward the green zone, looking for mean-reversion, rather than momentum persisting.  The red zone is pretty cyclical at present.  I will be very happy hanging out in dull stocks for a while.

P&C Insurers and Reinsurers Look Cheap

After the heavy disaster year of 2011, P&C insurers and reinsurers look cheap.  Many trade below tangible book, and at single-digit P/Es, which has always been a strong area for me, if the companies are well-capitalized, which they are.

I already own a spread of well-run, inexpensive P&C insurers & reinsurers.  Would I increase the overweight here?  Yes, I might, because I view the group as absolutely cheap; it could make me money even in a down market.  Now, I would do my series of analyses such that I would be happy with the reserving and the investing policies of each insurer, but after that, I would be willing to add to my holdings.

Do your own due diligence on this, because I am often wrong.  One more note, I am still not tempted by banks or real estate related stocks.  I am beginning to wonder when the right time to buy them as a sector is.  As for that, I am open to advice.

Implications

So, given that the Industry Rank categories above come from Value Line, I went to their stock screener, selected the industries, and asked for all of the companies that:

• are in their top 5 (of 9) categories for balance sheet strength, and
• their horribly overworked analysts think can return at least 15%/yr over the next 3-5 years.

This combines safety, growth potential, valuation, and in my view, how promising industry prospects are.  Here are the results:

ABC ADM ADTN AKAM ALL AMAT AMX AOL APOL ARB ARRS BIDU BRKR BX CAH CBEY CECO CELL CKP CL CNQ CPB CPSI CREE CTRP DNR DRIV DV EBAY EDU EFX ERIC ESI FST GMCR GOOG HCC HRC IN INFA INTC ISIL ITRI IVC JNPR K KKR KR LIFE LRCX LTRE MASI MCHP MDCI MKC NFLX NIHD NILE NOK NTRI NVDA NXY ONNN OTEX QGEN QLGC QSII RAX RIMM RMD SHEN SOHU STM STRA SWKS SWY SYY T THG TMO TNDM TRH TRI TSM TSRA TUP TXN UNTD UPL UTHR VOD VOLC VZ WBMD WBSN YHOO ZBRA

When I do my next portfolio reshaping for clients in the next week or so, these stocks (and a few others) will compete against the 35 existing portfolio names for the 34-36 slots in the portfolio.

Full disclosure: Long HCC, INTC, THG, VOD

A few notes:

• Checks and Undergrades are chicken eggs of low grade.
• Breaker Stock are eggs that are slightly better, but not good enough for retail.
• Greige = Un-dyed
• Vealers = Calves, used for veal
• Barrows and Gilts = Hogs

When I look at the top 50 risers, I think the following are in demand:

• Specialty hydrocarbons
• Dried peas, beans, nuts, etc.
• Fertilizer
• Eggs
• Some types of meat

Most of it boils down to a demand for food and energy.  These are very basic things, and to me indicate that there is demand for the basics.  I think this demand is global, as middle classes arise over much of the globe, food and energy will become more expensive.  A pity that the FOMC does not consider what people need to be material to their monetary decisions, despite the fact that food and energy have always had higher inflation rates, and there are better ways to deal with volatility (median, trimmed mean).

But what about the bottom 50?

One note: Finfish = real fish, as opposed to shellfish

When I look at the bottom 50 risers, I think the following are not in demand:

• Melons
• Many other fruits and vegetables.
• Low grade paper
• Some fish and shellfish
• Copper and other base metals

PPI File 12-2011

The above file contains all of the data for all categories in the PPI report.  My view of the data tells this story, which is consistent with what I have been writing for the last eight years: Resources are in short supply relative to capital and labor, for the most part, but not absolutely.

I still think that energy is an investable theme, agriculture and fertilizer may be so also.

My main industry model is illustrated in the graphic.  Green industries are cold.  Red industries are hot.  If you like to play momentum, look at the red zone, and ask the question, “Where are trends under-discounted?”  Price momentum tends to persist, but look for areas where it might be even better in the near term.

If you are a value player, look at the green zone, and ask where trends are over-discounted.  Yes, things are bad, but are they all that bad?  Perhaps the is room for mean reversion.

My candidates from both categories are in the column labeled “Dig through.”

If you use any of this, choose what you use off of your own trading style.  If you trade frequently, stay in the red zone.  Trading infrequently, play in the green zone — don’t look for momentum, look for mean reversion.

Whatever you do, be consistent in your methods regarding momentum/mean-reversion, and only change methods if your current method is working well.

Huh?  Why change if things are working well?  I’m not saying to change if things are working well.  I’m saying don’t change if things are working badly.  Price momentum and mean-reversion are cyclical, and we tend to make changes at the worst possible moments, just before the pattern changes.  Maximum pain drives changes for most people, which is why average investors don’t make much money.

Maximum pleasure when things are going right leaves investors fat, dumb, and happy — no one thinks of changing then.  This is why a disciplined approach that forces changes on a portfolio is useful, as I do 3-4 times a year.  It forces me to be bloodless and sell stocks with less potential for those with more potential over the next 1-5 years.

I like some technology names here, some energy some healthcare-related names, P&C Insurance and Reinsurance, particularly those that are strongly capitalized.  I’m not concerned about the healthcare bill; necessary services will be delivered, and healthcare companies will get paid.

A word on banks and REITs: the credit cycle has not been repealed, and there are still issues unresolved from the last cycle — I am not interested there even at present levels.  The modest unwind currently happening in the credit markets, if it expands, would imply significant issues for banks and their “regulators.”

I’m looking for undervalued and stable industries.  I’m not saying that there is always a bull market out there, and I will find it for you.  But there are places that are relatively better, and I have done relatively well in finding them.

At present, I am trying to be defensive.  I don’t have a lot of faith in the market as a whole, so I am biased toward the green zone, looking for mean-reversion, rather than momentum persisting.  The red zone is pretty cyclical at present.  I will be very happy hanging out in dull stocks for a while.

P&C Insurers and Reinsurers Look Cheap

After the heavy disaster year of 2011, P&C insurers and reinsurers look cheap.  Many trade below tangible book, and at single-digit P/Es, which has always been a strong area for me, if the companies are well-capitalized, which they are.

I already own a spread of well-run, inexpensive P&C insurers & reinsurers.  Would I increase the overweight here?  Yes, I might, because I view the group as absolutely cheap; it could make me money even in a down market.  Now, I would do my series of analyses such that I would be happy with the reserving and the investing policies of each insurer, but after that, I would be willing to add to my holdings.

Do your own due diligence on this, because I am often wrong.  One more note, I am still not tempted by banks or real estate related stocks.  I am beginning to wonder when the right time to buy them as a sector is.  As for that, I am open to advice.

The market takes action against firms that carry positions bigger than their funding base can handle.  Temporarily, things may look good as the position is established, because the price rises as the position shifts from being a marginal part of the market to a structural part of the market.  After that happens, valuation-motivated sellers appear to offer more at those prices.  The price falls, leading to one of two actions: selling into a falling market (recognizing a true loss), or buying more at the “cheap” prices, exacerbating the illiquidity of the position.

When an asset management firm is growing, it has the wind at its back.  As assets flow in, they buy more of their favored ideas, pushing their prices up, sometimes above where the equilibrium prices should be.

As Ben Graham said, “In the short run, the market is a voting machine, but in the long run it is a weighing machine.”  The short-term proclivities of investors usually have no effect on the long run value of companies.  Rather, their productivity drives their long-term value.

There have been two issues with asset managers following a “value” discipline that have “flamed out” during the current crisis.  One, they attracted hot money from those who chase trends during the times where lending policies were easier, and the markets were booming.  And often, they invested in financials that looked cheap, but took too much credit risk.  Second, they invested in companies that were seemingly cheap, rather than those with a margin of safety.

My poster child this time is Fairholme Fund.  Now, I’ve never talked with Bruce Berkowitz; don’t know the guy at all.  Every time I read something by him or see a video with him, I think, “Bright guy.”  But when I look at what he owns, I often think, “Huh. These are the stocks you own if you are really bullish on financial conditions.”

Yesterday, I saw a statistic that said that his fund was 76% invested in financial stocks as of 8/31.  Now I believe in concentrated portfolios, and even concentrated by sector and industry, but this is way beyond my willingness to take risk.  From Fairholme’s 5/31/2011 semi-annual report to shareholders, here are the top 10 holdings and industries:

Aside from Sears, all of the top 10 holdings are financials.  And, of those financials that I have some knowledge of, they are all what I would call “complex financials.”

In general, unless you are a heavy hitter, I discourage investment in complex financials because it is hard to tell what you are getting.  Are the assets and liabilities properly stated?  Financial companies are just a gaggle of accruals, and the certainty of having the accounting right on an accrual entry decreases with:

• Company size (the ability of management to make sure values are accurate or conservative declines with size)
• Rapidity of the company’s growth
• Length of the asset or liability
• Uncertainty over when the asset will pay out, or when the liability will require cash
• Uncertainty over how much the asset will pay out, or when how much cash the liability will require

It’s not just a question of whether the assets will eventually be “money good.”  It is also a question of whether the company will have adequate financing to hold those assets in all environments.  For financials, that’s a large part of “margin of safety,” and the main aspect of what failed for many financials in the last five years.

Another aspect of “margin of safety” for financials is whether you are truly “buying it cheap.”  All financial asset values are relative to the financing environment that they are in.  Imagine not only what the assets will be worth if things “normalize,” or conditions continue as at present, but also what they would be worth if liquidity dries up, a la mid-2002, or worse yet, late 2008.

Also remember that financials are regulated, and the regulators tend to react to crises, often making a marginal financial institution do something to clean up at exactly the wrong time, which puts in the bottom for some set of asset classes.  Now, I’m not blaming the regulators (or rating agencies) too much; no one forced the financial company to play near the cliff.  Occasionally, for the protection of the system as a whole, the regulator shoves a financial off the cliff.  (or, a rating agency downgrades them, creating a demand for liquidity because of lending agreements that accelerate on downgrades.)

Finally, think about management quality.  Do they try to grow rapidly?  That’s a danger sign.  There is always the tradeoff between quality, quantity, and price.  In a good environment, you can get 2 out of 3, and in a bad environment, 1 out of 3.  Managements that sacrifice asset quality for growth are not good long run investments, they may occasionally be interesting speculations at the beginning of a new boom phase.

Do they use odd accounting metrics to demonstrate performance?  How much do they explain away one-time events?  Are they raising leverage to boost ROE, or are they trying to improve operations?  Do they try to grow through scale acquisitions?

Are they willing to let bad results show or not?  Even with good financial companies there are disappointments.  With bad ones, the disappointments are papered over until they have to take a “big bath,” which temporarily sets the accounting conservative again.

The above is margin of safety for financials — not just seeming cheapness, but management quality and financing/accounting quality.  They often go together.

Fairholme’s annual report should come out somewhere around the end of January 2012.  What I am interested in seeing is how much of his shareholder base has left given his recent disappointments with AIG, Sears Holdings, Bank of America, Citigroup, Goldman Sachs, Morgan Stanley, Brookfield, and Regions Financial.  Even the others of his top 10 have not done well, and the fund as  a whole has suffered.  Mutual fund shareholders can be patient, but a mutual fund balance sheet is inherently weak for holding assets when underperformance is pronounced.

(the above are estimates, I may have made some errors, but the data derives from their SEC filings)

Now, we eat dollar-weighted returns. Only the happy few that bought and held get time-weighted returns.  And, give Fairholme credit on two points (though I suspect it will look worse when the annual report comes out):

• A 9.9% return from inception to 5/31/2011 is hot stuff, and,
• A 6.0% dollar-weighted return is very good as well.  Only losing 3.9% to mutual fund shareholder behavior is not great, but I’ve seen worse.

This is the problem of buying the “hot fund.”  Once a fund becomes the “Ya gotta own this fund” fund, future returns on capital employed get worse because:

• It gets harder to deploy increasingly large amounts of capital, and certainly not as well as in the past.
• Management attention gets divided, because of the desire to start new funds, and the complexity of running a larger organization.
• When relative underperformance does come, it is really hard to right the ship, because assets leave when you can least handle them doing so.  The manager has to think: “Which of my positions that I think are cheap will I liquidate, and what will happen to market prices when it is discovered that I, one of the major holders, is selling?”

That is a tough box to be in, and I sympathize with any manager that finds himself stuck there.  It can be a negative self-reinforcing cycle for some time.  My one bit of advice would be: focus on margin of safety.  If you do, eventually the withdrawals will moderate, and then you can work to rebuild.