Value Investing – Page 87

Reasons For Short-Term Optimism

Posted on 4 July 20075 July 2007 by David Merkel

Bond investors and value investors tend to be cautious in investing. It is possible to be too cautious, though, and so sometimes it pays to lay out the bull case. Indirectly, I learned this after several years of sitting next to the high yield manager at Dwight Asset Management (a very good firm that few know about). He wasn?t unconcerned about negative developments, but knew that fewer bad things happen than get talked about, and that they tend to take longer to happen than most imagine. He knew that he had to take some risks, because if you wait for the market to correct before you enter, you will miss profits while waiting, and the correction could be a long time in coming.

Also, I fondly remember our weekly economic conference calls in 2002, where the high yield manager and I would take the bull side in the discussions. For me it was fun, because it was so unlike me (I tend to be a bear), and it helped me to learn to balance the risks, and not be a perma-bull or a perma-bear.

So with that, here?s my quick list on what is going right in this environment:

Earnings yields are higher than bond yields, particularly among many investment grade companies, fostering buybacks and occasional LBOs. Profit margins may mean-revert eventually, but it might be a while for that to happen, given the global pressures that are keeping wage rates low.
The financing of the US current account deficit is still primarily being done through the purchase of US dollar denominated debt securities, keeping interest rates low in the US. This may shift if enough countries experience inflation from the buildup of US dollar reserves that they do not need, and allow their currencies to appreciate versus the US dollar. That hasn?t happened in size yet.
ECRI?s weekly leading index continues to make new highs.
Money supplies are growing rapidly around the world. Most of the paper is creating asset inflation, rather than goods inflation so far.
Bond yields have moderated since the yield peak in mid-June. Spreads on corporate investment grade debt have not widened much. Financing is cheap for the creditworthy.
Short sales are at a record at the NYSE. Part of that is just the influence of hedge funds.
Vulture investors have a lot of capital to deploy. Marginal assets are finding homes at prices that don?t involve too much of a haircut. (I?m not talking about subprime here.)
On a P/E basis, stocks are 45% cheaper than when the market peaked in March 2000.
Sell-side analysts are more bearish than they ever have been.
Investment grade companies still have a lot of cash sitting around. The washout from 2000-2002 made a lot of companies skittish, and led them to hold extra cash. Much of the cash has been deployed, but there is still more to go.
The FOMC is unlikely to tighten before it loosens.
Yield-seeking on the part of older investors is helping to keep interest rates low, and the prices of yield-sensitive stocks high.
DB Pension plans and endowments are still willing to make allocations to private equity.
The emerging markets countries are in aggregate in better fiscal shape than they ever have been.
Trade is now a global phenomenon, and not simply US/Europe/Japan-centric.
The current difficulties in subprime are likely to be localized in their effects, and a variety of hedge funds and fund-of-funds should get hit, but not do major damage to the financial system.

Now, behind each of these positives is a negative. (Every silver cloud has a dark lining?) What happens when these conditions shift? Profit margins fall, interest rates rise, inflation roars, risk appetites decrease, etc?

These are real risks, and I do not mean to minimize them. There are more risks as well that I haven?t mentioned. I continue to act as a nervous bull in this environment, making money where I can, and realizing that over a full cycle, my risk control disciplines will protect me in relative, but not absolute terms. So I play on, not knowing when a real disaster will strike.

Editing note — my apologies.? The second paragraph omitted the word “not” in the original publication.? What a word to omit, not. ??

Changes in My Insurance Longs

Posted on 3 July 20073 July 2007 by David Merkel

I have updated my insurance longs over at Stockpickr.com. (At present, I have no shorts, but if I did, I would not reveal them. Check my disclosure policy for details.) Here are the major changes:

I have sold Reinsurance Group of America, Allstate, Scottish Re (there was only a stub left), Endurance, Allied World, and Employers Holdings. I have bought Safety, Aspen, Argonaut, and PXRE. These changes have take place over the past few months. I have not mentioned them until now, because my employer was still building positions in the names; we are done now.
Why the changes? Here goes: with the exception of Scottish Re, I still like all of the companies and their management teams. By name:

Allied World and Endurance — nice runs. Not sure I want to hold them through storm season.
Aspen is a cheap substitute for AWH and ENH, maintaining some of my property exposure cheaper.
Argonaut and PXRE — merging. Argonaut got PXRE cheaply, and the deal makes good long term sense. Argonaut re-domiciles in Bermuda, and slow lowers its tax rate. It also further diversifies by writing property reinsurance, but not too much.
Allstate — I still own this in the broad market portfolio, but that has different objectives than the hedge fund that I work for. It has a longer time horizon. In the short run, Allstate will be pressured by increasing competition in the personal lines space. On the other hand, what a cheap valuation. I like it!
Scottish Re — can’t write new business. Very opaque earnings model. It is a pig in a poke, and I don’t think one can trust the book value.
Employers Holdings — I have to beg a mea culpa here, and say that my initial article on RealMoney was wrong. My goof? The prospectus was complex, badly worded, and I mis-estimated the true share count. After figuring out the true share count, I realized that the stock was fairly valued, not cheap. Apologies to all who went in with me on this; at least if I have to make an error, better to make it when no big losses are made.
Reinsurance Group of America — a real class act, but past my valuation parameters for now.
Safety Insurance — Very well run pure play personal lines insurer in Massachusetts, and cheap! Insulated from the general competition in personal lines in the USA.

Anyway, that’s what I am up to in insurance now, and how my portfolio differs from where I was in the first quarter.

Full disclosure: long AHL, AGII, ALL, PXT, and SAFT

Efficient Markets Versus Adaptive Markets

Posted on 2 July 200720 June 2017 by David Merkel

The Efficient Markets Hypothesis in its semi-strong form says that the current market price of an asset incorporates all available information about the security in question. Coming from a family where my Mom was a successful investor, I had an impossible time swallowing the EMH, except perhaps as a limiting concept — i.e., the markets tend to be that way, but never get there fully.

I’m a value investor, and generally, over the past fourteen years, my value investing has enabled me to earn superior returns than the indexes. A large part of that is being willing to run a portfolio that differs significantly from the indexes. Now, not everyone can do that; in aggregate, we all earn the market return, less fees. The market is definitely efficient for all of us as a group. But how can you explain persistently clever subgroups?

Behavioral finance has been the leading challenger to the efficient markets hypothesis, but the academics reply that behavioral anomalies are not an integrated theory that can explain everything, like the EMH, and its offspring like mean variance analysis, the capital asset pricing model, and their cousins.

Though it is kind of a hodgepodge, the adaptive markets hypothesis offers an opportunity for behavioral finance to become an integrated theory. First, behavioral finance is a series of observations about how most investors systemically misinterpret investment data, allowing for value investors and momentum investors to make money, among others. The adaptive markets hypothesis says that all of the market inefficiencies exist in a tension with the efficient markets, and that market players make the market more efficient by looking for the inefficiencies, and profiting from them until they disappear, or atleast, until they get so small that it’s not worth the search costs any more.

Consider risk arbitrage strategies for a moment. Arbitrage strategies earned superior returns through 2001 or so, until a combination of deals falling through, and too much money chasing the space (powered by hedge fund of funds wanting smooth returns) made it less worthwhile to be a risk arb. It is like there were too many fishermen in that part of the investment ocean, and the fish were depleted. After years of poor returns money exited the space. Today with more deals to go around, and fewer players, risk arbitrage is attractive again. No good strategy is ever permanently out of favor; after a strategy is overplayed to where the prospects of the assets are overdiscounted, a period of underperformance ensues, and it gets exacerbated by money leaving the strategy. Eventually, enough money leaves the the strategy is attractive again, but market players are slow to react to that, becaue they have been burned recently.

Strategies go in and out of favor, competing for scarce above-market returns in much the same way that ordinary businesses try to achieve above market ROEs. Nothing works permanently in the short run, though as a friend of mine is prone to say, “There’s always a bull market somewhere.” Trouble is, it is often hard to find, so I stick with the one anomaly that usually works, the value anomaly, and augment it with sector rotation and the remainder of my eight rules.

Now, I’m not a funny guy, so my kids tell me, but I’ll try to end this piece with an illustration. Here goes:

Scene One — Efficient Markets Hypothesis

An economics professor and a grad student are walking along the sidewalk, and the grad student spots a twenty dollar bill on the sidewalk. He says, “Hey professor, look, a twenty dollar bill.” The professor says, “Nonsense. If there were a twenty dollar bill on the street, someone would have picked it up already.” They walk past, and a little kid walking behind them pockets the bill.
Scene Two — Adaptive Markets Hypothesis, Part 1
An economics professor and a grad student are walking along the sidewalk, and the grad student spots a twenty dollar bill on the sidewalk. He says, “Hey professor, look, a twenty dollar bill.” The professor says, “Really?” and stoops to look. A little kid walking behind them runs in front of them, grabs the bill and pockets it.

Scene Three — Adaptive Markets Hypothesis, Part 2
An economics professor and a grad student are walking along the sidewalk, and the grad student spots a twenty dollar bill on the sidewalk. He says quietly, “Tsst. Hey professor, look, a twenty dollar bill.” The professor says, “Really?” and stoops to look. He grabs the bill and pockets it. The little kid doesn’t notice.
Scene Four — Adaptive Markets Hypothesis, Part 3
An economics professor and a grad student are walking along the sidewalk, and the grad student spots a twenty dollar bill on the sidewalk. He grabs the bill and pockets it. No one is the wiser.
Scene Five — Adaptive Markets Hypothesis, Part 4
An economics professor and a grad student are walking along the sidewalk, and the grad student is looking for a twenty dollar bill lying around. There aren’t any, but in the process of looking, he misses the point that the professor was trying to teach him. The professor makes a mental note to not take him on as a TA for the next semester. The little kid looks for the twenty dollar bill as well, but as he listens to the professor drone on decides not to take economics when he gets older.

It was a Good Quarter; Also, my Favorite Managers

Posted on 30 June 200730 June 2007 by David Merkel

It’s good to be back home with my wife and kids. There truly is no place like home, particularly when things seem to be working well with my wife and kids.

Two quick notes, because I’m kind of tired:

I wondered at many points this quarter whether I would beat the S&P 500 or not. Not counting my unpaid dividends and interest, I can say that I was ahead by 110 basis points for the quarter, bringing the year-to-date figure to 590 basis points. I don’t expect to win every quarter, and not every year either, but the streak is at six years now, and I hope to prolong it. Let’s see how I do at the next portfolio reshaping, which should come this week.
One of my readers asked for my favorite mutual fund managers. Here they are: Marty Whitman at Third Avenue, Ron Muhlenkamp at the Muhlenkamp Fund, Don and Craig Hodges at the Hodges Fund, Ken Heebner at CGM, and Bob Rodriguez at FPA. (There are other value managers I like as well, Tweedy Browne, and Heartland Value, to name a few. I am a value guy, but I like rotating sectors.)

All of these managers are willing to look for cheap assets, and sectors that are undervalued. That’s what I do, and my record is comparable to theirs, though I run a lot less money.
Here’s to a great second half of the year. Let’s make some money together, or, at least not lose more than the market.

Another Win for the Broad Market Portfolio

Posted on 28 June 2007 by David Merkel

Well, score one more for my portfolios, Komag is being bought by Western Digital for $32.25/share. This was a remarkably quick win, given the initial purchase back in late March, and a rebalancing buy in late May.

Investments rarely work this quickly, but I am grateful when they do. In the last portfolio reshaping back in March, I put more weight on EV/EBITDA, and Komag scored well there. I’ll be selling Komag at the portfolio reshaping, which should take place in the next two weeks.

I sometimes mention that my investment methods allow me to be away without worrying too much; this closing week of the quarter is one more example of that, at least, so far.

PS — On another note, wasn’t it interesting today to see the market get excited about the supposedly dovish FOMC language, and then sell into the reality that nothing had changed?? I chuckled; people expect too much of the FOMC…

Full disclosure: long KOMG

Portfolio Reshaping Mid-Year 2007, Part 2

Posted on 23 June 2007 by David Merkel

Here are my current industry ratings.? Using my Bloomberg Terminal, I? ran a screen looking for cheap companies in those industries.? The result yielded eight tickers:

ACO CONN GMRK HES NSIT PDE SMRT SSI

I also added in the top 12 tickers from the last time that didn’t make it into my portfolio, and aren’t on the current list.? Here are the tickers:

ABFS [DBK GR] FINL FL GGC HERO [NGX CN] PTSI RADN SNSA URI WIRE

If you have other stock ideas for me, let me know (post a comment!).? Remember that I am a value investor.? I like them cheap.

Aside from any names that readers might give me, my list of possible replacements is done.? All that is left is to run my valuations/technicals model, and think about what to but and sell.? Early next week, I will run those models, and make the decisions by Independence Day.

Portfolio Reshaping Mid-Year 2007, Part 1

Posted on 23 June 200723 June 2007 by David Merkel

Well, the second portfolio reshaping of the year has begun. To refresh your memory on what I do here, you can review this short post. Here are the tickers from my initial stack, candidates to replace my current portfolio:

ABY ACI ACTU AFN APA ARLP ASEI BBG BHP BLX BMI BOW BTU BVN C CBE [CMB PE] CMC CNX CQB [CRY CN] CRZ CTHR CTL CVX CWEI CY DELL DNR DVN DVR EMR EOG EPEX EPL ERF ESV FCGI FCX FRD FRO FRX FSS FST FTO GIFI GMK GMR GSF GVHR GW GYI HHGP HNR IDCC IMMR IMOS INTX IO IR ITW IVAC KAR KEP LRCX LRW [LUN CN] MEOH MGS MKSI MLR MRO MTL MVC NAT NBL NBR NFX NR NRP OMM OPMR PCZ PH PRKR PTEN PVX PWE R RDC RDS RGS RIG RIO ROK RRC RSH S SHOO SPH SPI STZ SU SWKS TAP TLM TPL TSO TX TXI TYC UNT UNTD UPL WCC WDC WFC WIN XTO

If you have ideas, post them in the comment section of this post.? I’ll be running my industry model and an additional screen to generate a few more tickers, and then the comparison to my current portfolio. I should have more later today. Till then.

Nine Notes on Speculation

Posted on 21 June 200722 June 2017 by David Merkel

Recently I have been clipping articles, and arranging them by category, so that I can comment on them as a group more easily.? Tonight’s topic is speculation again, but these articles are all of the odd bits that don’t follow any particular theme.

Sometimes I think that the major financial press that covers Wall Street should send chocolates to Jim Cramer for creating TheStreet.com.? Where else would they get high quality journalists the understand the markets?? Writing for RealMoney, Matthew Goldstein would occasionally e-mail me with a question.? He was the one who covered financials in the news group for TSCM.? Financials are harder to learn than industrials, and I thought he would go far.
Well, he has gone far, to Business Week.? The advent of hedge funds has created a great demand for shorting stock, and there are concerns on the part of some with naked shorting, where one does not borrow the shares before they are sold.? This article describes the probe into stock lending, and what may come of it.? Personally, I wonder why investment banks don’t create single-name total return swaps.? E.g., receive three month LIBOR plus or minus a spread, pay IBM total return.? That would allow the same economics of shorting, without the stock borrow, and no charges of naked shorting.? Why not?
Brave new world; the uptick rule is history.? Well, that should provide more liquidity to buyers.? I’m indifferent on this one, though I would warn anyone doing a death-spiral convert that the elimination of the uptick rule means there is no way that the short sellers won’t win.
Once you have derivatives, almost anything is possible.? Insider trading can be hidden through derivative instruments, because they are not publicly reported.? Now, in practice, it may not be that simple, because derivatives are a zero sum game, and the counterparty loses what the one with information wins, unless they are hedged.? Whoever bears the loss after the takeover is announced has a concentrated interest to find the one who ended up winning, because they might get back what they lost.
I think it is inevitable that there will be different ways of trading large and small blocks of stock.? Most industries have different distribution methods for wholesale and retail.? Dark pools of liquidity don’t surprise me; when I was a bond trader, if I wanted to trade a large fraction of some bond deal, quietness and anonymity were crucial.? My view: have the SEC serve as trading apprentices a large equity or bond shops, and see why large trading is different from small trading.
Fitch gets it, maybe.? They see why hedge funds might be weak holders during a crisis.? I’m not sure what Fitch will do with it, but that skepticism will make for a better rating agency.
130/30 seems to be coming along at the wrong time.? There is too much pressure on the borrow from hedge funds already.? My opinion is that short-selling is getting close to useless on average, given the high level of shorting.? When the bad event happens, the covering keeps the stock afloat.
No more earnings guidance? Yay!!? Let analysts be real analysts, and not just take what management has fed them.? I like it when companies I follow eliminate earnings guidance, because it increases the advantage of analysts who really understand what is going on.
Investing in commodities was a great idea until players started to invest in an indexed manner on the front month.? This has forced the front month to be low versus future months, and the continuing roll depresses returns.? If I were running such a fund, I would invest in a ladder of contracts similar to the pro-rata ladder of contracts currently traded; that would minimize the antiselection.
Finally, be wary of funky ETFs that don’t actually own the underlying assets in a direct way.? There are too many ways for those vehicles to go wrong.? Good ETFs have direct ways of hedging that keep the prices in line with what they are trying to replicate.

That’s all for now.? My own investing has gone well so far this week, but who can tell what the future will bring?

Supply and Demand Factors in the Equity Market

Posted on 18 June 2007 by David Merkel

My posting philosophy when doing commentary on the news is not to do “linkfests,” much as I like them, but to try to give a little more thought behind what has been written, and try to weave them into a greater coherent whole.? My career has been diverse; if I wanted to be mean I would say that I was a dabbler, a patzer, a dilettante.? A jack of all trades and a master of none.? The strength of my varied career is that I have insights into a wide number of areas in the markets, and how they interconnect.? I have always believed that understanding multiple markets helps shed light on each one individually.

So, when I comment on the news, it is my aim to give you a broader perspective on the major factors influencing our investment decisions.? That also means that I might not be commenting on what is breaking news, but on what trends are going on behind the scenes.? Today’s topic is supply and demand factors in the equity market… the true technical analysis. 😉

Let’s start with Jeff Miller at A Dash of Insight. He gives the classic case of why a management would buy back stock.? A management team is able to capture more of the excess returns that the business is earning by substituting cheaper debt for equity in their capital base.? In moderation, this is a decent strategy; it is a strategy increasingly employed because of high profit margins and low interest rates.

Now, as you go through this discussion, you will run into the term “Fed Model.”? The Fed model is a simplified version of a discounted cash flow model, where the earnings of an equity market are discounted using a common interest rate, frequently a long treasury rate, and compared to the current price, to see whether stocks are rich or cheap.? (Note: this calculation does not actually prove whether stocks are absolutely rich or cheap, but only rich or cheap relative to bonds.)? In practice, the calculation can come down to comparing the earnings yield of an index (earnings divided by market capitalization) to the yield on the long Treasury note.

Use of this model is controversial and can produce widely varying results depending on your assumptions.? Take for example, this article over at Trader’s Narrative. It draws the conclusion that the market is “extremely undervalued” at these levels.? This is true, if interest rates and credit spreads stay low, and profit margins stay high.? All three data series tend to mean revert, so how long these factors remain favorable is open to question.? Nonetheless, in the past, comparing treasury and earnings yields was a smart strategy.? Will that continue?

John Hussman ably argues that profit margins are mean-reverting, and that the relationship of earnings yield to bond yields has been spotty at best.? I agree with both of those ideas, but with some caveats:

Profit margins could remain high for a longer time than anticipated because of increased globalization, and increased willingness to lever up.
The relationship of earnings and bond yields has gone through eras where there has been extreme greed and fear.? That earnings and bond yields do not track perfectly is not a weakness, but a strength of the model.? If they tracked perfectly, there would be nothing to game here.? At extreme differences the yield differential produces signals that will make money, and reduce risk to investors.? (Personally, I like my models to explain half of the variation or so — a good balance between there being a signal, and having significant noise to exploit.)

I expect profit margins to mean-revert, but what if they don’t do so quickly?? As an example, consider the upside surprise delivered in the first quarter.? US corporations don’t just depend on the US economy anymore; they sell outside the US, and buy resources outside of the US, even labor (outsourcing).? With a weak dollar, earnings in dollar terms surprised on the upside.? Buybacks also increased earnings per share.

Ignore Shiller when he does the 10-year average earnings.? 10-year averages are less representative of future earnings than the current year’s earnings.? There has been a lot of earnings growth for sustainable reasons.? Could earnings pull back significantly?? Yes, but not to the 10-year average, unless we get a depression.

What of rising interest rates?? Will they derail the equity market?? Some think so.? Some think not.? My view is that at around 6.50% on the 10-year Treasury, bonds would present serious competition to stocks.? Down here around 5.15%, we will continue to have the substitution of debt for equity through LBOs and buybacks.? Despite the volatility, investment grade credit spreads are still tight, and the collateralized loan obligation market is still active, allowing LBOs to be more easily financed.? Further, there is a yield hunger on the part of buyers that allows corporations to sell debt, even subordinated debt cheaply.? This will eventually change, but we need some genuine failures of investment grade companies to demonstrate the real risks of borrowing too much.

In the short run, that IPOs are being well-received is a plus to the market.? There is demand for stock.? In the long run, buying at low P/Es is also a plus (ask David Dreman).? That’s not true now, except relative to bonds, which are providing little competition to stocks.

So where does that leave me?? My view is more complex than many of the caricatures being trotted out.? Let me give you the main ideas:

Comparing earnings yields to bond yields is useful, but must be done with discretion.
Profit margins will mean-revert, but given globalization, and its effect in restraining wages, that may be a while in coming.? How much do you want to leave on the table?
Demographic trends should keep real interest rates low.? The graying of the global Baby Boomers is one of the factors keeping interest rates low.? Retirees and near-retirees want income, and that is surpressing interest rates.
Also suppressing interest rates are those that have to recycle the US current account deficit.? Until we see large currency revaluations in countries that have large surpluses with the US, rates should stay low.
Until we get a significant set of defaults in the credit markets, credit spreads should stay low.? At present, there is too much vulture capital lurking, waiting to buy distressed assets.? The distressed investing community needs to be seriously scared; then maybe valuations will head south.

So, reluctantly, in the short run I carry on as a moderate bull.? That said, the valuations in my portfolio are cheap relative to the market, and the balance sheets are stronger than average.? The names are inclined more toward global growth than US growth.? Many companies in my portfolio have buybacks on, but none are doing it to the level where it compromises their credit quality.

Trends have a nasty tendency to persist longer than fundamental investors would anticipate.? So it is with the markets at present.? Honor the momentum, but keep one eye on shifts in interest rates and profit margins.

Nine Business Days Ago

Posted on 15 June 2007 by David Merkel

The most recent closing high in the S&P 500 was on June 4th.? Since then, we have been through a spin cycle where all that mattered were yields on the long end of the Treasury curve.? That’s why I wrote late on Thursday at the RM Columnist Conversation:

	David Merkel
	Bonds and Stocks Decoupling? They were only Together by Accident.
	6/14/2007 4:50 PM EDT

I was somewhat skeptical when I saw bonds and stocks trading in tandem. The relationship between bond and stock earnings yields is a tenuous one operating over the long haul and on average. Using the five-year Treasury as and the S&P 500 my proxies, bond yields have exceeded earnings yields by as much as 8% in the mid-’50s, while earnings yields have exceeded bond yields by more than 4% in 1981, 1984 and 1987. On average earnings yields are 32 basis points over bond yields. If there is mean reversion in the difference between the two yields, the effect is not a strong one. At present, the relationship between earnings and bond yields seems tighter because of the large substitution of debt for equity going on, but that’s not a normal thing in the long run.

Even with all the buybacks and LBOs, it isn’t normal for stocks and bonds to trade in a tight correlated way in the short run, so, take one of your eyes off of bonds, and look at the fundamentals of the companies that you own. You’ll make more money that way, and take less risk.

PS: if the ten-year crosses 5.50%, go ahead and look at bonds again, and maybe allocate some more money to fixed income. Repeat the process each 0.5% up, should we get there. Equilibrium for stocks and bonds on a valuation basis is a 6.50 10-year. We’re not there yet, so I expect the substitution of debt for equity to continue, albeit at a slower pace.

Sometimes I think investors and the media search for an easy target on which to pin their fears or hopes.? In this case, it was the bond market.? Don’t get me wrong, the bond market is important, and usually ignored by investors to their peril.? But using the bond market to make short term equity trading decisions is just plain silly.

Now, when actual volatility rises, my methods usually do well against the broad averages.? One of the things that I have tried to achieve in my adaptive approach to the markets is to create a system does does well in calm markets, but does relatively better in volatile markets.? Volatile markets scare inexperienced investors into making the wrong moves.? My methods are geared toward allowing ordinary investors to benefit from volatility in a rational way.? As I stated in the CC on Friday:

	David Merkel
	Rebalancing Trades
	6/15/2007 11:55 AM EDT

Wow. Nice rally over the last chunk of time, and it’s time to “ring the register” and lighten on a few names that have run nicely. I do this primarily for risk control purposes. Here are the names that I trimmed: Noble Corp (NE), Cemex (CE), Lyondell Chemicals (LYO), and Tsakos Energy Navigation (TNP). They are now back at their target weights in my portfolio. My rebalancing discipline is a way of:

Lowering risk on companies that are more expensive, and thus more risky than when I last bought them.
Raising exposure on names that are cheaper, and thus less risky than when I last bought or sold them.
Capturing swings in sentiment in industries, companies and the market as a whole, without becoming a momentum trader.
Lowering my market impact costs by leaning against the wind (selling into a rise, buying into a fall), and
Forcing a review process at certain price levels
Taking the emotion out of selling and buying
Making an additional 2% to 3% a year on my portfolio.

You can only do this with a high quality portfolio; don’t try this with companies that have a non-zero chance of a severe drop. For more information, review my “Smarter Seller” article series.

Position: long NE LYO TNP CX

Since 6/4, my broad market portfolio has outperformed the S&P 500 by roughly 1%.? My methods are designed to be able to cope with volatility and some back smiling.? Why can I go on business trips or vacation and not worry about the markets?? Why don’t I get scared by many of the negative macroeconomic situations out there?? First, I trust in Jesus; my life is not just the markets.? But beyond that, my eight rules are design to deal with the volatility that the market serves up, and adapt to what is undervalued in the present environment.

My plan for the next three weeks on the blog is to go through another portfolio reshaping.? You’ll get to see how I make choices in my portfolio.? Beyond that, I have one big article on the Fed Model coming, and continuing coverage of the major factors driving the markets.? Have a great weekend.

Full Disclosure: long CX TNP LYO NE