Stocks – Page 126 – The Aleph Blog

Last Post Before I Leave Again

Posted on 28 June 200822 June 2017 by David Merkel

What did I do last week while the market was being whacked? I bought some Reinsurance Group of America, Shoe Carnival, YRC Worldwide, SABESP, and Universal American. I reduced cash in the portfolio from 11% to 8%. It may have hurt me in the short run, but should be good in the long run.

I have modest concerns about the current profitability of Smithfield Foods, but no concern about their long-term profitability. They have an intelligent management team. I may buy some more soon.

Now, as to my comments yesterday regarding quantitative risk measures: yes, I am highly skeptical. Economics is not Physics. The relationships are not stable enough for the quantitative statistics to be valuable. I go back to what Buffett said, “I’d rather have a noisy 15% than a stable 12%.” If you have a long time horizon, why do you care about standard deviation or beta? If you have a short time horizon, why are you investing in risk assets?

Risk is not short-term variation, unless your time horizon is short. Consider my article on longevity risk.? All good risk management considers when the money will be needed. Risk is unique for each person, and can’t be summarized through a “one size fits all” statistic. What are the odds of not meeting the goals of the investor? How severe will the shortfall be? That is risk.

Personally, I am annoyed at the consultant community. They employ statistics that have little relation to future performance in an effort to earn fees. They get away with it because clients don’t get investing. They buy the concept of randomness, and ignore the managers with good processes that have been hit by bad short-run performance.

Eventually value investing wins. Do value investors calculate the Modern Portfolio Theory [MPT] statistics before investing? Of course not. They know that their job is to find undervalued businesses. They don’t care about market trends.

As you consider investments, ignore MPT. It is better (if you have a long horizon) to focus on overall investment processes, with a review of the names in the portfolio over time, to get a feel for the methods of the manager.

Full disclosure: Long SBS SCVL RGA YRCW UAM SFD

Recent Portfolio Moves

Posted on 21 June 2008 by David Merkel

Selling 70% of my National Atlantic stake freed up cash, and I deployed half of that today in a variety of rebalancing trades.? Today I bought some Jones Apparel, Valero Energy, Hartford Financial Services, and OfficeMax.? I sold some RGA to buy some MetLife, in order to get cheaper RGA.

Today’s actions brought cash in the portfolio from 14% to 11%.? It’s a good time to be adding to positions in a modest way.? If the market declines further, I will continue to slowly reduce cash and add to positions.? One nice thing about the rebalancing discipline is that I don’t time the market, but it often seems like the rebalancing discipline forces buying low and selling high, in ways that most investors would not want to emulate, because I am constantly leaning against the wind.

Starting on Monday, I’m going to be on the road until July 8th.? My ability to blog and follow the markets will possibly be impaired, because I will be busy the first week with the annual meeting (Synod) of my denomination, and the next week, with my parents’ 50th wedding anniversary.? I will be in rural Western Pennsylvania and Northern Wisconsin, respectively.? The first is a lot of work; the second, a lot of fun.? In both cases, Internet access may be spotty.

I’ll leave a few standing orders out to take advantage of further declines in the market, especially if the NAHC deal fails on Monday.? Beyond that, I will start in on the next portfolio reshaping when I return.? For those that want an early preview, here are my current industry ranks.? It’s been a good year so far, but who can tell, the market can spin on a dime, and once again find a new way to make fools out of us all.

Full disclosure: long NAHC JNY VLO HIG OMX MET RGA

Inflation and Stocks

Posted on 19 June 200819 June 2008 by David Merkel

I read this article today, and it made me want to write on the topic.? This is a concept that I learned early in my investment career.? It is worth understanding, so that you can do better in investing.? Inflation is negative for stocks, but it is a small negative — for every 1% that the inflation rate goes up, stocks decline 2% on average.

That’s not very big.? So why do stock investors panic over inflation?? They panic because the Fed might respond to inflation, and raise real (inflation-adjusted) interest rates enough to quell inflation.? Rises in real interest rates are far more negative to the market — a 1% rise in real rates hurts the equity market by 10%.? Why such a big impact?

The impact is large, because when real interest rates are high, capital is scarce.? Go back to my “Fed Model” article which is very different from other “Fed Models.”? High corporate bond rates raise interest costs for corporations, reducing profits, and raising discount rates (cost of equity capital).

At present, real interst rates are negative — in nominal dollar terms, this is not a bad time to own stocks.? Think of the dividend discount model for a moment.? Inflation runs through earnings and the discount rate, so the effect is muted.? Real rates run through the discount rate only — poison.

Is there any hope in an era where inflation is rising, and where real rates may rise?? Value investing always offers some hope, but that’s not my main point here.? Inflation manifests itself differently in different eras.? Look for the areas that are in short supply.? They will be the areas where corporations will have pricing power.? Those areas will outperform the market, even if the market as a whole declines.? At present, I am looking at energy stocks, food stocks, and others.

Inflation is bad for the market, but don’t let that stand in the way of looking for what might offer relative profit in this environment.

National Atlantic Notes

Posted on 17 June 200817 June 2008 by David Merkel

The last several days have been interesting to me regarding National Atlantic. It started with a discussion with another person who worked for my former employer (no, not the same one as last time). It went something like this:

Friend: Did you see the filing by our old boss?

DM: Yes, but unless he files suit alleging fraud, it is unlikely to amount to much.

F: Good point. What do you think the odds are of the deal going through?

DM: The deal is more likely to go through than not, but if the deal does fail, the stock will fall to $4, and if the deal succeeds it will go to $6.25. The payoff is asymmetric. I think the odds are 65% that the deal goes through.

F: So why are you holding on if the odds are that poor relative to the rewards?

DM: Uh…

So, on Thursday of last week and yesterday, I sold away 70% of my position after voting “no” on the deal. My thoughts: it is quite possible that the deal will get voted down. Sure, it isn’t in the short term interest of stock holders to see the deal fail, but National Atlantic has so annoyed shareholders that many will vote against their short term interests because of the egregiousness of the deal.

As an aside, NAHC is the sort of stock that if you are not careful, a large order can disrupt the market; I ended up using discretionary reserve orders routing through Arca [NYSE Archipelago], which allowed me to show 100 shares with much more behind that, and have discretion to lift bids within a penny of the stated offer. I was able to sell a lot without disturbing the market.

If the deal does get voted down, I will buy back in, at much lower prices. If it succeeds, I will take the small gain and move on.

Full disclosure: long NAHC

The Bottom for the Banks

Posted on 14 June 200815 June 2008 by David Merkel

There are many people calling for a bottom to banking stocks, and I must admit, it is a tempting place to play. I never thought Fifth Third would trade so low. Or Keycorp. Royal Bank of Scotland, sorry, I sold you early in 2008; yes, I thought you would fall. When does the excessive leverage finally eliminate the CEO?

Here’s the challenge for investors: on the one hand, you have declining earnings per share in the near term, from losses and capital raises. But when have equity prices fallen enough to discount the future losses?

I am being cautious here. I own no banks.

Here’s another way to think about it — after all of the bad debts are written off, and bad banks eliminated, what kind of earnings stream will be attractive?

I’ll use the homebuilders as an example here — at troughs, they sometimes trade for half of written-down book value, The question becomes the final side of the book value after the writedowns.

I would still be cautious here, but markets are discounting mechanisms — we are getting closer to a bottom in the banks; we are not there yet.

Book Review: The Wall Street Waltz

Posted on 13 June 200813 June 2008 by David Merkel

I’ve mentioned this before at RealMoney, but in early 2000, I was doing some serious thinking about investing. I decided to e-mail Ken Fisher a question that he had touched on in one of his Forbes pieces. That began an e-mail dialog that forced me to ask hard questions about how I did value investing. Personally, I was surprised how much time he was willing to waste on me, but I had read the three books that he had written up to that time, Super Stocks, 100 Minds that Made the Market, and The Wall Street Waltz. I had a good idea of how he approached investing.

He challenged me to throw away the CFA Syllabus and think independently — to focus on my own competitive advantage. That led me to analyze what had worked and failed in my prior efforts in value investing, and that led to what would become the Eight Rules. I did well in the prior era, but much better after my discussion with Ken Fisher.

One more note before I begin the book review. He told me that if something is known, it is not valuable for investing. I have modified that rule to be, “If something true is relied upon by many investors, it is not valuable for smart investors. If something false is relied upon by many investors, it is valuable for smart investors to bet against that.”

The Wall Street Waltz takes you on a graphic tour of economic and financial history. Using beautiful old charts created by multiple sources, he uses them to describe market action in the past, and what they might imply for the present. The original version, of which I have a copy, was written in 1987. The new edition updates Ken’s comments to 2007.

The charts provide a springboard for Fisher to explain a wide number of concepts:

Why preferred stocks are suboptimal investments. (Chart 31 — learned that first hand a a little kid as I saw my Litton convertible preferred crater.)
How economically linked Canada is to the US (Chart 15)
The value of P/E ratios for the market (Charts 1&2)
Why you shouldn’t panic over bad political/disaster news. (Chart 24)
How inflation is correlated internationally (Chart 49)
Gold preserves purchasing power in the long run, but that is about it. (Chart 57)
Stocks create value in the long run, despite short/intermediate-term fluctuations. (Chart 88)

I could go on. I chose those pages randomly. There is a wealth of knowledge here. I would like to close with a timely page that I targeted, Chart 64 — Unemployment and the 1 Percent Rule. The stock market tends to rally after the unemployment rate rises 1%, though the challenge is timing when to sell, and I don’t know what the rule should be for that. After the last unemployment report, the rate is more than 1% over the recent low. If correct, it is time to be a buyer, though what is true on average is not always true in specific.

Most investors don’t benefit from an understanding of economic history, which gives a broader skill set for analyzing current problems. This book is an aid in gaining understanding of economic history.

Full disclosure: If anyone enters Amazon through my site and buys something, I get a small commission. Your costs are not increased. This is my equivalent of the “tip jar” and so, if you like what I write, and need to buy through Amazon, please enter Amazon through links on my site.

Rebalancing Buy

Posted on 11 June 200822 June 2017 by David Merkel

Nothing big here, I’m just making a point of reporting my portfolio moves here. Yesterday, near the close, I did a rebalancing buy of Group 1 Automotive. I had a rebalancing sell on GPI recently, so this is part of selling high and buying low.

I still think that the auto dealers are more immune to recession than most players in the auto business. In addition to selling new cars, they sell used cars, and provide service. The latter two services are recession-resistant.

Also, in this environment, I have been deploying my excess cash slowly, and the allocation to Group 1 is a means of taking advantage of a swing down in its stock price.

Full disclosure: long GPI

Hearing from the Proxy Solicitor

Posted on 10 June 200810 June 2008 by David Merkel

To whom it may concern: please send your agent soliciting my proxy to charm school. I don’t like being pushed to give my vote over the phone. I don’t regard it as secure as the internet or paper balloting.

Yesterday was a funny day, I received three communications (in this order) on National Atlantic.

The paper proxy and ballot.
An e-mail from some dear friends pointing out our former employer’s SC 13D/A, declaring their opposition to the deal.
The call from the proxy solicitor.

As I said to my friends: “I suspect that by this time, Gorman [the CEO] plus the arbs hold more than 50% of the shares. I will be voting my 0.15% against the deal, for what good that will do.

There are no appraisal rights, and I think the only possible remedy would be lawsuit alleging fraud, with a temporary restraining order on the deal. I don’t think that a lawsuit would succeed, but the laws of NJ, and the regulators are management-friendly.”

I have already admitted defeat on this one. Should the merger vote fail, I would expect the stock to drop considerably, because without replacing the current management team, there are no good options.

Full disclosure: long NAHC

Recent Portfolio Moves, and Insurance Company Musings

Posted on 7 June 20088 June 2008 by David Merkel

On Friday, toward the end of the day, I added to my position in Cemex, just to rebalance the portfolio and take advantage of undue weakness in the Mexican stock market.

Earlier in the day, though my timing was good, it could have been better, I swapped my exposure in Japan Smaller Capitalization Fund [JOF] for the SPDR Russell/Nomura Small Cap Japan ETF [JSC]. Given that I like JOF, why did I trade? The premium to NAV got too high — it was 10% on an intraday basis by my calculations, so, I traded. Eventually it will go back to a discount of -5% or so, and I will reverse the trade. I still like Japanese Small caps, but I have my limits when it comes to NAV premiums.

Away from that, I am still considering trading away some/all of my RGA for some MetLife, since I think it will be a cheap way to acquire more RGA. I’m glad the separation has finally come for MetLife and RGA; it was only a question of when. RGA is a unique company; unless Swiss Re, or Munich Re, or Aegon wants to spin out their Life Re business, there are no other pure play life reinsurers out there. Reinsurance of mortality in the present environment is a cozy oligopoly, with one former main player, Scottish Re (spit, spit), badly damaged. (Though I lost badly on Scottish Re, I am still grateful that when I figured out what was going on, I was able to sell at $6+/sh. Current quote: 14 cents/sh, and I hope that MassMutual and Cerberus are enjoying themselves. I took enough lumps for my patronage of Scottish Re, so anyone who sold when I did is at least that much better off.)

Pricing power isn’t anything amazing here, because the life insurers in general have enough capital, and are not ceding as much business to the reinsurers. But it is a steady business, and one with barriers to entry — ACE and XL will try to get into the business, and Scor will try to improve its position, but RGA, Swiss Re and Munich Re will be tough to dislodge.

I am looking forward to the next reshaping, and considering industry trends… I’m really not sure which way the portfolio will go, but I am gathering tickers and industry data, and preparing for the next change.

One last note: did you know that I am overweight financials? Yes, but only insurance companies, and Alliance Data Systems. (I still don’t trust the banks, and particularly not the investment banks.) The insurers that I own are cheap to the point where earnings don’t need to grow much to give me good value over the long run, and are largely insulated from any hurricane activity this year. Now, if the winds blow, you can expect that I will do a few trades to take advantage of mispricing among reinsurance companies. That said, Endurance, Aspen, Flagstone, and PartnerRe look cheap to me at present. Endurance looks very cheap… I have owned all four in the past, and will probably own some of them again in the future. But, no major commitments until the wind starts blowing (hurricanes), or if we get to the middle of the hurricane season (say, mid-September), and nothing has happened. Then it would be time to buy. Damage from windstorm tends to be correlated within years — bad years start early, and are very bad. Good years are quiet, and continue quiet with a few storms doing low levels of damage.

Anyway, that’s what I am up to. Got other ideas? Share them with my readers!

Full disclosure: Long CX JSC RGA ADS

Don’t Do It!

Posted on 5 June 2008 by David Merkel

Fifteen years ago, when I was still pretty much a novice investor, I went to an AAII meeting to hear Jeremy Siegel speak about his new book, “Stocks for the Long Run.”? I brought my copy to have him sign it.? I hung around after the talk to? listen to some of the more informal things he might say, and in a dead moment, I asked him (something to the effect of),? “You suggest that young people should lever up to buy stock; do you really mean that?”? His answer was and unreserved “Yes.”

Dr. Siegel is brighter than me.? The guys who write the CXO Advisory Blog are brighter than me as well.? Felix Salmon is clever, and he puts up this supporting piece.

I am here to disagree.? Why?? It is all very well and good for academics to assume that returns occur randomly, but returns occur in streaks.? Think of all of the “lost decade” articles you have seen in the recent past.? Here’s my main reason for not levering up while young: It won’t work well about? one-third of the time, because young people will take humongous losses during a “lost decade,” and in the panic, they will sell at the wrong time.? My secondary reason, is that in really bad markets, such as 1929-32, 1973-4, and 2000-2002, you could be wiped out.

Don’t trust the results that rely on the veracity of Modern Portfolio Theory, when those ideas would have failed off of historical returns.? As I often say, “The markets always have a new way to make a fool out of you.”? This is another example.

One final note, perhaps more scholarly: the idea of levering up requires buying and holding, and that bad markets happen randomly, with no streaks.? Unfortunately, the equity market returns less than a buy-and-hold investor receives, because people buy and sell at the wrong times.? Buy-and-hold investors are daring people; they confront the natural tendencies toward greed and panic, and they do better than average in the long run.? One buying and holding on leverage would have to have a steel gut, which is not characteristic of younger investors.

So, don’t lever up.? I say this to investors young and old, experienced and inexperienced.? Getting an equity-like return is difficult enough in the long run.? Don’t make your life more difficult by levering up.