Stocks – Page 138 – The Aleph Blog

TheStreet.com Video on the Federal Reserve

Posted on 27 October 2007 by David Merkel

While in NYC, I did two videos on the Federal Reserve for TheStreet.com.? Here is the first of them.? The second one should be published soon.? Please pardon my inability as I express myself, but it’s a fair picture of what I look like, sound like, and how I think (or not) on my feet.

I got to see what a day at TheStreet.com is like, from the video facilities, to how coverage changes as news breaks (Merrill Lynch being the example du jour).? I got to meet several people face-to-face who I had never met before: James Altucher, Kristin Bentz (indeed fair-haired and ingenious), George Moriarty, Gregg Greenberg, Simon Constable, Farnoosh Torabi (of course), Mark DeCambre, and many other members of the staff.? Especially fun was lunch with my editor Gretchen Lembach.? I saw a few others that I knew (including James Cramer, who was in a good mood, but busy, as you can imagine.? I don’t think he recognized me.), but they were busy.? It’s a low key, fun, and connected kind of place; I’ve never seen as many monitors showing CNBC in one place, aside from some of the bulge bracket trading floors.

After my time at The Street.com, I had an interview with a major insurance company in NYC.? Hopefully something will come of that, even if it is only a consulting relationship.? One impressive thing about the company that I visited: the offices of the senior management were the most modest that I have seen in the industry.? In any business, that’s a good sign; it shows that they are concerned about the shareholders.

It is also possible that my relationship with TheStreet.com will expand as well.? I’ll be putting together a proposal for them, and we will see where it goes.? Oh, one more thing; if anyone reading this is short TSCM, do yourself a favor and cover.

Tickers mentioned: TSCM

Momentum and Growth

Posted on 24 October 2007 by David Merkel

I make no pretense to being anything more than a value manager.? It’s what I’ve done for the past fifteen years, with pretty good results.? Granted, my new methods over the past seven years attempt to incorporate industry rotation in two ways:

Industries where pricing power is near there nadir, such that the only direction is up, given enough time.? Strong companies in weak industries survive weak pricing cycles, and do well when the cycle turns.
Industries where pricing power is underdiscounted, and it will pay just to wait for future earnings to validate a higher P/E.

But no, I don’t explicitly focus on earnings growth, though I do look at forecast earnings for next year, which embeds a future ROE forecast.? I ignore growth forecasts for several reasons:

Growth forecasts tend to mean-revert.? Low growth companies tend to surprise on the upside, and high growth on the downside.? With a little help from pricing power, I tend to get more good surprises.
ROEs also tend to mean-revert.? Competition enters spaces with high ROEs and exits spaces with low ROEs.
It’s rare for a high growth, high P/E company to grow into its multiple.
Low growth, low P/E companies can be treated like high-yield bonds.? A P/E of 10 implies an earnings yield of 10%; I may not capture all of that 10% in dividends and buybacks, but a modestly good management team will find ways to deploy excess cash into other organic growth opportunities which will grow earnings in the future.? With a little good management, I can see my company with a P/E of 10 grow its intrinsic value by more than 10% in a year.

As for momentum, my rule of thumb is that momentum persists in the short run, and mean-reverts in the intermediate term.? I have to size my trading to the rest of my strategies.? Value emerges over the intermediate term, not rapidly.? The same tends to be true of industry rotation; it works with a lag, but it works.? I have to become like Marty Whitman at that point and say that often the fundamentals and price action are lousy when I buy, and for me that’s fine, because:

I focus on balance sheet quality,
Accounting integrity, and
Cheapness.
I have my rebalancing discipline standing behind me, which often has me buy more before the turn occurs.
I also stay reasonably well-diversified.

The turns usually do occur.? I never make a ton of money on any trade, but typically 80% of my trades make money. And, my losses are typically small, so this method works well for me.

Anyway, that’s why I embrace negative momentum and don’t explicitly embrace growth.? It can place me in the “caricature” camp for value managers, because my valuation metrics are usually lower than most.? Given my longer holding period, I’m fine with that, because low valuations tend to produce their own catalysts for change, if one has done reasonable research on the shareholder-friendliness of the corporation, and the strength of its financials.? Besides, as intrinsic value grows with companies having low valuations, there is a strong tendency for the stock to rally.? Think of PartnerRe, which has never had a high valuation; as it puts up good earnings year after year, the price of the stock keeps running.? Just another example of an underdiscounted trend in the markets.

Full disclosure: long PRE

Eight Notes on Insurance, Economics, and Value Investing

Posted on 23 October 2007 by David Merkel

Doug Kass over at RealMoney made the following comment: “The next shoe to drop will be the failure of a public homebuilder and a private mortgage insurer. The latter concerns me more than the former, as the markets are not aware of the economic implications of my view.”? An interesting comment to be sure.? Unlike other insurers that benefit from state guarantee funds, the mortgage insurers do not so benefit.? That said, in a concentrated sub-industry that has only seven players (MTG, RDN, PMI, TGIC, GNW, ORI, and AIG), one advantage that poses is that failure of one company will not lead to assessments on the rest of the companies, leading to cascading failures.? So who would be affected?? Fannie and Freddie would get a lot of credit risk back, as would any private lender that used the mortgage insurers to reduce risks.? Even some of the mortgage originators with captive mortgage reinsurers would take some degree of a hit (most of the top originators had these).
Some younger friends of mine asked me for advice recently, and the question came up, “Should I invest in the market, or pay down debt?”? Now, we weren’t talking about credit card debt, which they paid off in full every month.? They did have a home equity loan at 8.5% fixed.? My view was this: with 10-year Treasuries yielding 4.4%, and marginal investment grade corporate bonds yielding 6.0% or so, a reasonable return expectation for the equity markets as a whole would be in the 8-9% region.? Add 2-3% to the BBB-bond yield, and that should be a reasonable guess, given that I think the market is somewhere between lightly undervalued and fairly valued.? My advice to them was to pay down the home equity loan, and once it was paid off, invest in an index fund, or a diversified mutual fund.? Until then, better to earn 8.5% with certainty, than 8-9% with uncertainty.
As can be seen from my recent reshaping, yes, I do buy sectors of the market that look ugly.? Shoe retailers and mortgage REITs have not done well of late.? Am I predicting no recession by buying the retailers?? No; so long as the shoe retailers aren’t too trendy, demand for shoes is relatively stable, and these stocks are already discounting a recession.? I chose two that had virtually no debt, so I am on the safer side of the trade, maybe.
Does buying a mortgage REIT mean that I am betting on further FOMC loosening?? No.? The mortgage REITs that I hold embed a pretty nasty set of assumptions for the riskiness of the safest parts of the mortgage bond markets.? While a FOMC loosening would probably help, I’m not counting on that.
My value investing is different than most value investors, because I spend more time on industries, either buying quality companies in beaten-up sectors, or companies with pricing power, where that power is underdiscounted by the market.
If we are trying to estimate the central tendency of inflation and eliminate volatility, it is better to use a trimmed mean, or median, rather than toss out volatile components like food and energy, particularly when those components have led inflation for the last 5-10 years.? The unadjusted CPI is a better predictor of the unadjusted CPI than is the core CPI.
Personally, I think the next ten years will be kinder to “long only” equity managers than hedged managers.? There is only so much room for shorting, which is an artificial overlay on the system.? We aren’t at the limits of shorting yet, but we are getting closer to those limits.? It would not surprise me to see ten years from now to find that balanced fund managers beat hedge fund managers on average (after correcting for survivor bias, which is more severe with hedge funds).? It’s much easier and more effective to do risk management in a long only mode, and I believe that the virtues of long only management, and balanced funds, will become more apparent over the next ten years.
I’m thinking of doing a personal finance post on what insurance to buy.? Is that something that readers would like to read about?

October 2007 Portfolio Reshaping

Posted on 22 October 200723 October 2007 by David Merkel

The reshaping file can be found here. In order to stay in compliance with the Bloomberg data license, I only include numeric fields that I have calculated. My ranking method ranks the companies in my portfolio, and all replacement candidates by several variables:

Relative Strength (lower is better, double weight)
Trailing P/E
This year’s P/E
Next year’s P/E
Price-to-book (double weight)
Price-to-sales (double weight — financials are counted as average)
Dividend Yield
Net Operating Accruals (a measure of accounting integrity — double weight — financials are counted as average)

I rank the companies on all of the criteria, weight the ranks, and calculate a grand rank. I look for the company that I own that has the middle rank for all of my currently owned companies, and I sell a few companies that I own below that, and buy some new companies near the top of the list. Here are my actions:

Sales

Sara Lee
Dow Chemical
DTE Energy

Purchases

Redwood Trust [RWT]
Gehl Corp [GEHL]
Shoe Carnival [SCVL]
Charlotte Russe Holding [CHIC]

Future Sale

One reinsurer — could be Flagstone, PartnerRe, or Aspen Holdings.

Rationale

I have enough reinsurance names going into earnings. If you need more of an example of how well they will do this quarter, then look no further than PartnerRe’s solid earnings report this evening. On the other sales, DTE Energy and Dow Chemical were solely for valuation reasons. Sara Lee is another matter; my confidence that they can turn around the company is reduced, and valuation is not compelling.

As for purchases, on the shoe retailers, there were a bevy of cheap names, but Shoe Carnival and Charlotte Russe seemed to have the most consistent operations, and low debt. Gehl seems to be in a good industry, small agricultural machinery is in demand, and valuations are modest. Finally, Redwood Trust seems to be well-run as mortgage REITs go. Asset quality is good and leverage is moderate. Also, the debt is all from securitizations, so it is non-recourse to the company; the most that can happen is that the assets in the securitizations depreciate to the degree that their residual interests are worthless.

One other shift that is unintentional here, is that my portfolio becomes more small cap in nature. I am selling away larger companies, and buying smaller ones. That is an accident of the process, but occurring because there are some genuinely cheap companies to buy. Time will tell as to whether these are good purchases, but most of what I like in investments are lining up here.

Full disclosure: long PRE AHL FSR CHIC SCVL RWT GEHL

Crash Remembrances

Posted on 20 October 200721 October 2007 by David Merkel

On Friday over at RealMoney, I posted the following:

		David Merkel
		1987 Memories
		10/19/2007 5:20 PM EDT

I was a young actuary when the crash hit in 1987, one year and change into my career. I did not have any investments at that time, but I had just bought a house with my (then) new wife. Few today remember that the crash of 1987 was the culmination of three separate crashes. In late 1986, the US Dollar hit new lows, amid massive intervention by central banks. In February 2007, I came down with a bad cold that sidelined me for four days. Cuddled up with the WSJ while my wife was at work, I concluded that the bond market was about to fall apart, so we accelerated buying a small home. Two months after we completed the financing, mortgage yields rose by 2% during the bond market meltdown.

The stock market roared on, though. Through August, the market rose, and the earnings yield shrank. Bond yields remained stubbornly high; it was a great time to invest in high quality long bonds, particularly long zero coupon bonds.

The eventual crash in October is no surprise to me today. Equities could not stand the competition from bonds, so the market slumped from August to October, until the pressure of dynamic hedging took over starting on Friday the 16th, selling into a declining market in order to maintain the hedges, and spilling over in a self-reinforcing way on the 19th. For what it is worth, there was a humongous rally in long bonds as people sought safety.

Now, my Mom was buying the day after the crash. This is why she is more professional than most professionals I know. She bought solid companies that would survive bad times. I knew far more people who sold into the panic. As for me, I got a trial subscription to Value Line, and picked six stocks, which I sold too soon for a 20% gain, and didn’t return to direct investment in single equities until 1992. (I used mutual funds.)

Since then, I have been consistent in plying my advantage in picking cheap stocks where the fundamentals are under-discounted. It’s been a good niche for me, maybe it can be of value to you as well.

PS — no bounce today, kinda like October 16th, 1987.

Position: none

Now, should the crash have been bought? Yes, at least in the short run, even without knowing the verdict of history. The difference between stock and bond yields narrowed dramatically, and option implied volatility was making a bold effort to escape earth orbit. Beyond that, fast moves tend to mean revert; slow moves tend to persist.
Now, my knowledge of the markets was rather crude back in 1987, so I never would have caught those then; nor did most commentators at the time. People were too scared to be rational. Even the FOMC blinked, with a neophyte Greenspan, with no serious crisis imminent, thus beginning his career of throwing liquidity at small problems, and leaving the consequences for later.

Well, at least I bought the lows in 2002. That event was similar, but not nearly as short-run severe as 1987, though it had the “strength” of longer duration as a bear market.

Before I close for the evening, I would like to mention that I will have the portfolio reshaping complete on Monday, and watch for it here first. As an aside, there are a lot of cheap small cap shoe retailers, and a lot of cheap general and apparel retailers also. I don’t normally buy retailers, but this time things are too cheap. Expect to see me buy one.

Additional Tickers for the October Reshaping and Reader Questions

Posted on 17 October 2007 by David Merkel

Here are therebalan additional tickers for the upcoming reshaping:

AE ALE ARA ATO BAC BAMM BBW BONT BWS C CEC CHIC CHRS CPB CTR DBRN DF DLM DTE DUK FINL FL FMD GEHL GYI HAIN HLYS HNZ HZO JOSB JPM KSWS MW NI NWY ODP OGE PLCE POR PSS PTEN PTRY RSC RT SCVL SGU SHOO SLGN SMRT SRE TUES UNH WLFC WR WTSLA ZONS

And now for a reader question on the original reshaping candidates list:

What?s your ranking system? Have you written a note about it? Also, what was the criteria for inclusion in the list above?

I?ll probably suggest some other stocks as a function of the above. Also, as a value investor myself, I think the following pair of questions is worthy of reflection and debate: 1) Is undervaluation better thought of as a ranking factor or a safety factor – e.g. should one try to pick the most undervalued stocks so they go up the most, or should I try to pick stocks with most improving outlook and use undervaluation and/or low growth estimates as a safety net in case they blow up? 2) To what extent should I use the valuation measure that makes the most rational sense to me vs. the one that gives the best empirical match to market behavior ( fine to reference mean reversion in the answer, but I expect that one can fit data over a long time frame and still find important differences between the two).

Answering in order:

The ranking system comes in the next phase.
Inclusion criteria was that it looked interesting at some point in the last four months.? Anytime I get an idea, I write it down, and wait for the reshaping.? By waiting, I avoid making hasty decisions, or trusting the authority of another clever investor.
Undervaluation — ranking or safety?? Why choose?? They are by nature both at the same time.? Truly undervalued companies have higher upside and lower downside compared to more richly valued peers.
Your last question is one that I have thought about a lot and concluded that there is either no good answer, or the data involved is out of my reach.? If you use the one that matches market behavior, then you end up doing relative value trades, but if you use one that takes into account average valuation over time, you can play for mean reversion, but may miss some relative value.? If we had enough data, and a regression package that could do cross-sectional time-series, we could try to isolate both effects, and perhaps figure out when companies and factors are cheap, independent of each other.? Would love to try it, but that would be costly.

One more reader question:

I am interested in your feelings on GLYT. I have recently bought this company. The reported in-line earnings back in July but guided lower, and the market took out their frustrations on them.

They have shown growth both in revenues and earnings and have been pairing down their debt.

Let me know your thoughts

I’ve owned GLYT twice in the 90s.? Great management team; wish I’d never sold it, even though I made good money on it both times.? It’s more expensive today than when I owned it before, and the growth opportunities may not be as good as they were.? If it scores closer to the top of my list, I’ll take a closer look.

Industry Ranks October 2007

Posted on 17 October 2007 by David Merkel

Here are my Industry Ranks October 2007 for the current portfolio reshaping.? Remember that my ranks can be used two ways.? If you are a value guy like me, you pick from the bottom quartile, the green zone, for out-of-favor industries.? I further filter that by striking out industries that in my subjective opinion, still have more pain to take.? That’s why housing, housing finance, and housing related names are absent.

If you are a growth or momentum player, pick from the top of the list, because in the short run, momentum tends to persist.? In the intermediate term momentum tends to mean revert.? I play for the latter of those two momentum effects, because I am not much of a trader, and I think the effect is more reliable, and tax-effective.

Later today, I’ll post my final list of additions to the candidates list for the portfolio reshaping, after running an industry screen.? Then over the next three days, I’ll get to work on the reshaping.

Society of Actuaries Presentation

Posted on 13 October 200720 June 2017 by David Merkel

Finishing off the presentation proved to be harder than I estimated, together with all of my other duties.? Well, it’s done now, and available for your review here.? For those looking at one of the non-PDF versions, you might be able to see the notes for my talk as well.

I’m writing this before I give the talk.? If I had it to do all over again, I would have made the talk less ambitious.? Then again, of the four topics that I offered them, they picked the most ambitious one.? When you look at the talk, you’ll see that it is a summary of the macroeconomic views that frame my investment decisions.? The presentation will run 40 minutes or so, plus Q&A.? Reading it is faster. 🙂

Enjoy it, give me feedback, and I’ll be back to normal blogging Monday evening.

Swamped With Work, but Here’s a Dozen Observations

Posted on 9 October 2007 by David Merkel

I’m swamped with putting the finishing touches on my talk for the Society of Actuaries, so this post will be brief.? When it’s done, I’ll be posting it here for all of my readers.? When the transcript gets published, I’ll post that as well, but that takes a while.

A few observations, some of them obvious, because we’re at an interesting juncture in the markets now:

The equity markets are near new highs.? Who’da thunk it?
Equity implied volatilities have returned to a semi-normal state, and corporate credit spreads have tightened, but lagged.
Fixed income implied volatilities look high.
Fed policy, if LIBOR, narrow money, or the monetary base is the measure, hasn’t worked that well.
Fed policy, if the stock market or total bank liabilities is the measure (credit expansion), has worked pretty well.
The dollar has bounced, but I would expect it to retrace the losses.
We’re experiencing a small period of macroeconomic quiet amid the start of earnings season.? Earnings season should be good overall, with weakness in housing-related areas, and strength in export-related areas.
Banks should be able to end the logjam in the LBO debt markets.? The cost is feasible.
Residential real estate prices are still weakening, and provide most of the drag on the US banking system and economy.
Inflation is rising with many of our trading partners; the US may begin absorbing some of it.
Our trading partners are going to have to choose between controlling their interest rates, and following US policy, or letting their exchange rates rise further.
In this environment, I am trimming my equity portfolio slowly as positions hit the upper end of their trading bands.? 20% of the portfolio is within 5% of the upper rebalance point.? Almost nothing is within 10% of my lower rebalance point, so I’m not likely to add anytime soon.

The Next Portfolio Reshaping Starts

Posted on 6 October 2007 by David Merkel

Every 3-4 months, I do a comprehensive review of my portfolio, comparing all of my current companies to a set of potential buy candidates.? The buy candidates come from all sorts of sources, and I do my best to forget who gave them to me, so that I can approach them fresh.? Here are the candidates:

ACH ADP AHN AIB AIG AKR AMGN APA ARP ATI BBD BBV BJS BK BLL BMA BMO BP BTU BWA CAH CCK CCRT CENX CHT CMI CNQ CNX CODI COF COG CPA CPL CR CRI CRK CS CTL CVH CVX CW CXW DDS DEI DFS DRC DSX DVN ECA EIX EMC EOG EPD EQ EXP FCX FLR FLS FRX FWLT GFI GLYT GNI GOL GOLD GR GSB GSF HCC HD HDL HGRD HLX HSR IBCP IM IMOS INFY IR IRE ITU IVN JCI JCP JEC JNJ JOYG JRT JWA KBW KEG KFT KMP LM LMT LNT LOW LSI MBT MBWM MDR MEOH MER MI MMC MOS MPG MRO MU MVO NBR NC NCI NEM NOV NTRS OXY PBR PBT PCH PCL PCZ PG PMD PNC POPEZ POT PPC PTI PXP QTM R RAIL RDY REXI RHI RIO RRD RS RTP RWT RYN SAN SBR SDA SE SGR SGY SII SKX STD STT STX STZ SVVS SYNT T TBSI TD TEN TEVA TEX TLM TRS TSO TTM TWIN UBS UFS UG UHT USB USG USTR VCP VIP VIV VSL VZ WDC WFC WHG WLL XTO XTXI

Alphabet soup, I’ll tell ya.? Here’s where we go from here:

Update my industry models.
Run a screen off of the results of the industry models to pick up a few more ideas.
Scrub the quantitative data for errors.
Run my ranking system.
Fundamentally analyze the top buy candidates to find a few good buys.
Look at the bottom of my current companies in the rankings to decide what I sell to fund the buys.

And, if you have a company you’d like to toss into the mix, let me know.? I’ll toss it in.? This process should complete sometime in the week that begins on 21st, because I need to finish up preparations for a speech that I am giving on the 15th.

Many tickers mentioned, but I own none of them.