Helping Institutions and Ordinary People Invest Better by Focusing on Risk Control
The Broad Market Portfolio was off 1.8% today. Three stocks were up, and 32 down. Down over 4% were Deerfield Triarc, Barclays plc, SABESP, and Lithia Automotive.
The US market is only somewhat oversold. Given the weakness in the Asian markets, I would not be surprised to see more weakness tomorrow.
Full disclosure: long DFR BCS SBS and LAD
The broad market portfolio was only up 10 basis points today, against greater moves for the major averages. Leading the charge on the downside was Fresh Del Monte. Nothing was materially up, aside from Griupo Casa Saba.
There’s a lot of “I told you so” going on in the pundit-sphere at present regarding subprime mortgages. Those that have read me at RealMoney know that I have been talking about the problems there for the past 2-3 years. I will say this, the shrillness of the Johnny-come-latelys on the issue almost make me want to reconsider my opinion.
I’ll have the results of my comparison of competitors to my portfolio available tomorrow. I’m still scrubbing the data.Full disclosure: Long FDP SAB
The Broad Market portfolio was up a little more than 2% this week. The economic sensitivity of the portfolio helped, as did the Latin American names in the portfolio: SABESP, Cemex, Industrias Bachoco, and Grupo Casa Saba.
The week was characterized by a retreat from perceived systemic risk As the week went on risk went from general to localized. The true offenders in the subprime lending world were taken out and executed, and the rest of the market recovered.
I have been sounding bullish of late, but I want to caution you regarding the dangers of this present market. Though this panic did not spread to the market on the whole, it is possible that a future crisis might be more virulent. Remember, the current market prosperity relies on free trade in goods and services; any interruption of that could lead to a major decline. Bad FOMC policy is another risk here as well. Profit growth has slowed significantly as well. There are reasons to be concerned, but if you are concerned, tweak your portfolio toward less risk. Don’t leave the party entirely, but choose stocks with strong balance sheets and cheap valuations, and raise a little cash.
Full disclosure: SAB IBA CX SBS
I have several industry rotation models.? Some are short-term, others are longer term.? My main one is in the back of my head as I analyze where the pain is growing, and nearing maximum intensity.? (If anyone wants me to share shorter term models, I can do that.? I don’t use them much though.)
For me, the idea in industry rotation is to find stocks that fit one of two paradigms: 1) strong companies in troubled industries, and 2) well-run, cheap companies in industries where favorable trends are over-discounted.? My main model attempts to address the former.
My model has 6 1/2 years of Value Line industry rank data.? It asks the following questions:
The results from these questions are weighted and turned into a grand rank. From highest to lowest, the weights go 1, 4, 3, 2 for the questions listed above.? This spreadsheet lists the final results.?? Now the new ranks can be used in two ways, in value mode, or momentum mode.
Value Line ranks are a product of three factors: price momentum, earnings momentum, and analyst surprise.? They are momentum driven.? My model attempts to refine that, and give investors two ways to play the market.? If you like fast momentum-style trading, buy the companies in the red zone near the bottom of the list.? If you’re like me, buy the companies in dead industries in the green zone at the top of the list.
So what did I do here?? The list of industries entitled “dig through” I deemed interesting from the “green zone.”? I ran a screen on them to get a few more names for this current portfolio reshaping.? Here are the tickers:
HERO ADM SMG SE ABFS CMC CVX ESV GMRK GSF HES MRTN NAT NE NX OXY PDE PTSI RADN RDC SHOO TSO
Okay, so now I have two things ready to go: I have the full list of tickers that I will compare against my current portfolio.? I also have what my main industry rotation model recommends.? I call my methods “quantitative assisted,” because I use my intellect to overrule them when I think it is needed.?? The next step is lining up all of the candidates against my current portfolio to help decide who to add in , and who to kick out.? More on that on Monday.
This is a little out of the ordinary for those who frequent my blog, but here is something that my wonderful wife and I use to help our children learn math. If you did not already know, we homeschool our eight children. We are not big on math drill; we think word problems teach reasoning far better. But to do word problems effectively, the ability to have instant recall of the 100 math facts in addition, subtraction, multiplication and division is crucial.
We have our children work at it until they can get it perfect in five minutes in third grade, and three minutes in fifth grade.
To use the spreadsheet (right-click and use “save link as” to download), select the tab that you want to work on. “little add, and “little subt” are the 64 math facts with no number greater than 10. To use the sheet, hit the F9 key to recalculate the sheet, which places all the problems in a new random order. (You’ll never get 2 sheets the same.) Then hit the print icon. F9, print, F9, print, etc… pretty soon you’ll have a lot of unique sheets for drill purposes.
Use and distribute as you see fit. I just want to see children who are good with their math. And, if it works for you, let me know.
Last year, I wrote and ill-timed piece at RealMoney entitled, ?Life in Warren’s World Is Expensive,” and a follow-up, ?Buffett the Businessman.” I claimed that Berkshire Hathaway was overvalued. It has since risen by 15-20%. I am eating my crow, and wish that I had more salt.
Trouble is, I think that my thesis is still correct. I view Berkshire Hathaway as an insurance company that uses its liability structure to fund its operating businesses. To me, the performance of the insurance enterprises is a critical aspect of whether Berkshire is a good or bad investment.
In 2006, Berky wrote some of the riskiest coverages that the rest of the insurance industry would not touch on the property side of the business. Then came a ?no catastrophe? year. Is it any surprise that the stock is higher? Give Buffett credit for the AAA balance sheet that allowed him to be the last man standing in writing risky property coverages. Even in this year?s letter, he says he is willing to lose $6 billion in a single event. Pricing is slipping, and I have no doubt the Berky won?t chase the pricing down below levels where they can?t make their profit on average. That may mean that Berky will have a lot of idle cash.
Warren has changed his tune regarding retrocessional coverages in the last few years. In the 2007 letter, he explains how it can be used to ameliorate the risks of other insurers. This is a good and proper use of retro. In years 2005 and prior, he would crow about his riskless deals, which no doubt passed accounting muster, even if they missed the spirit of the regulations.
Berky has $50-70 billion to put to work. I don?t see how they can do that easily. Berky?s acquisition pattern over the past few years is to scrape up a few distressed companies, and a few companies where the owner was willing to sacrifice on price to preserve the culture. Outside of bold moves like acquiring ConocoPhilips outright, I don?t see how they can deploy that much capital.
Give Buffett credit for staying in enough of his foreign currency trade to draw a profit from it. I agree with Buffett over the state of our national finances, and think the dollar is headed lower over the intermediate term. That said, I increased my size of the trade when he lightened up in 2006.
Finally, they are looking for a successor to Buffett. Whoever that man may be, he will have to reckon with a few realities. If the objective is to grow long term book value, what is he best way to do that? Hold onto cash and wait for a crisis? Buy reasonably priced operating businesses with a hope of growth? Wait for utilities to go on sale? Behave like Magellan, Contrafund, or any other large mutual fund? (Not Buffett?s way.)
In summary, I can?t see Berky doing that well over the next twelve months because of the weak pricing environment for insurance, and the difficulty the Buffett will have in deploying the free cash of Berky. It is a more competitive environment for investments, which means that Berky will not deploy much cash.
Full Disclosure: Long COP
Today the broad market fund was up about 75 basis points, which isn’t that amazing. Leading the parade were Cemex, Fresh Del Monte (that has been on a tear), SABESP, and Lyondell Chemical. Bringing up the rear were… wait, none of my stocks were down more than a percent yesterday. That’s a pretty broad based rally.
In general, the markets feel like the majority of players are concluding that they don’t have to worry about systemic risk for the nonce. Swap spreads, bond spreads, implied volatility, and other variables show a continued willingness to take risk. I wouldn’t want to say that I like being a short term bull; there are many worries in the present environment. But at present, the willingness to take risk and finance risk taking persists. That may change, but until then, the bull market continues. I will combat risk through my ordinary risk control mechanisms, as described in my eight rules.
I’m going to have to defer on my industry models for one more day because of time constraints.? Apologies.
Full disclosure: Long CX FDP SBS LYO
Up about 1/4% today, against a lousy market. Giving extra help today were Valero Energy (though I sold a little), Helmerich & Payne, and ConocoPhillips. Hurting the cause were Royal Bank of Scotland and Lithia Automotive.
Is the recent panic over? Yes and no. No, because you can never tell what additional macroeconomic problems will crop up. Yes because CDOs [Collateralized Debt Obligations] are still getting funded. I have a saying that bubbles only pop when cash flow is insufficient to finance them. Well, the riskiest part of the debt markets, CDO equity, still has willing participants. That indicates that it is not bubble-pop time yet, and that has positive implications for the junk debt and equity markets. Party on!
Industry models tomorrow.
Though it is something that will grow, the major article list section of this blog is now up-to-date. It is a complete index of my long-term writings at RealMoney (primarily).
The one thing that would make it better would be to index my long term Columnist Conversation posts. It is my favorite part of RealMoney, and that is why I have concentrated there, even though I don?t get paid for cc posts. (sad that) What would be interesting would be to scour my cc posts for long term value, though I have over 1500 cc posts. I?m not doing that anytime soon. 80% of my cc posts are ephemeral, and I?m not sure it is worth the effort to get the other 20%.
I can’t remember the last time that all of my stocks were up. 28 of them were up by more than 1%. If anyone would like to track the performance of my broad market portfolio, I have it listed at Stockpickr.com. Two notes though, at present I am running with 8% cash, and Allstate and the Japan Smaller Capitalization fund are roughly 1.5x the size of the largely equal-weighted portfolio. Today, the portfolio continued to beat the S&P 500, returning roughly 1.9%. Leading the charge were Fresh Del Monte (what a move over the last month), Barclays plc, Royal Bank of Scotland, SABESP (wish it had gone down more, would have bought a bunch), and Deerfield Triarc. Deerfield Triarc pointed out that as a mortgage REIT, they had minimal exposure to subprime mortgages. No surprise to me, but in this environment, everyone is suspect. Nice yield of around 10%.
ABY ACI ADM AGU AIMC AL AMGN AMK APPB AVT AXL AYI BBV BEZ BG BGG BLX BP BPOP BRL BRNC BTU CAJ CAKE CALM CAR CAT CHK CMI CMP CNQ COO DB DF DGX DSW DT DUK EAC EAT ECA EMN ENI EPD ESV EVEP FCL FINL FL FSTR GGC GI GIL GMK GMR GPI GRC GSF HAL HES HSOA HTCH HTZ ICO IDCC INSP IOM JRCC KBR KOMG KONG KPN LABL LAD LCUT LINE LMC LNG LNX LRW LSCO MCHX MEE MEG MOT MU MUR MWE NAT NBR NCOC NEM NFX NGPC NOV NTE NXG NXY NZT OCR OPMR PCA PD PDS PHG PMTC POT PSO R RAD RDC RIG RIO RSG RSH RTP SCM SKX SNSA SON SPC STX STZ SUG SVU SWFT TAP THE TJX TK TKR TMA TMO TNP TOT TSCO TSN TSO TUES UNT URI VLI WDC WERN WIRE WPI WTI YRCW YZC
The next two tasks are calculating the industry ranks from two different models, and setting up the spreadsheet so that I can compare companies against one another. That’s for tomorrow and Thursday.
Full Disclosure: Long ALL FDP BCS RBSPF SBS DFR JOF