Stocks – Page 16 – The Aleph Blog

Two Bits of Advice for the Fed

Posted on 19 September 201520 September 2015 by David Merkel

Here are two ideas for the Fed, not that they care much about what I think:

1) Stop holding regular press conferences and holding regular meetings. ?Only meet when a supermajority of your members are calling for a change in policy. ?Don’t announce that you are holding a meeting — perhaps do it via private video conference.

Part of the reason for this is that it is useless to listen to commentary about why you did nothing. ?You may as well have not held a meeting. ?Another reason is that governors could act more independently if a meeting can’t be called unless a supermajority of voting members calls for it.

Yet another reason is that the frequent and long communication has not eliminated the Kremlinology that exists to interpret the Fed. ?When changes to the FOMC statement are small, they get over-interpreted — remember the “taper” comment? ?Far better to say nothing than to repeat yourself with small meaningless variations.

Along with that, you could eliminate issuing statements altogether, and go back to the way things were done pre-Greenspan. ?Need it be mentioned that monetary was executed better under Volcker and Martin? ?We don’t need words, we need to feel the actions of the Fed. ?That brings me to:

2) Stop trying to support risky asset markets. ?It is not your job to give equity or corporate bond investors what they want. ?If you do that, too much liquidity gets injected into the system, creating the financial bubbles of 2000 and 2007-9.

Instead, give the risk markets some negative surprises. ?Don’t follow Fed funds futures; make them follow you. ?Show them that you are the boss, not the slave. ?Let recessions do their good work of clearing out bad debts, and then the economy can grow on a better basis. ?Be like Martin, and take away the punchbowl when the party gets exciting.

Do these things and guess what? ?Monetary policy will have more punch. ?When you make a decision, it will actually do something.

Realize that policy uncertainty is not poison for risk markets. It forces businessmen to avoid marginal ideas — things that only survive when the weather is fair. ?The accumulated underbrush of bad debts doesn’t keep building up until the eventual fire is impossible to control.

If were going to have fiat money, do it in such a way that bubbles do not develop, which means not caring about the effects of policy on risky asset markets. ?This might not be popular, but it would be good for the economy in the long run.

-==-=–==–==–=-=-=-=-=-=-=-=-=-=-=-=-=-=-=–=-=

As a final note let me end with one chart from the recent data from FOMC participants:

I?suspect the FOMC will tighten in December, but remember that the FOMC doesn’t have a roadmap for the environment they are in, and they are acting like slaves to the risky asset markets. ?Another burp in the markets, and lessening policy accommodation will be further delayed.

Book Review: Market Liquidity Risk

Posted on 9 September 2015 by David Merkel

Liquidity is ephemeral, and difficult to define. ?The first real article at my blog was about liquidity, and the three things that liquidity can mean, notably: the ability to:

Enter into large or exit from?commitments to risk assets cheaply (cost)
Borrow at tight credit spreads compared to the safest borrowers
Make large adjustments to their asset allocations rapidly (speed)

Most of these phenomena can be observed without complex models. ?Ask yourself:

Is credit growing rapidly?
Are the exchanges moving turning over stocks more rapidly?
Are credit spreads tight?
Have credit terms and conditions deteriorated?
Do lenders care more about volume of lending than quality of lending?

My bias is that I think most of the academic mathematical models of liquidity risk are overly technical, and tend to obscure liquidity conditions rather than reveal what is going on. ?You may disagree with that view.

But unless you disagree with that view and you like math, this book will not be worth a lot to you. ?Yes, there are qualitative sections, and they are good. ?For example, the beginning of chapter 2 is very good at illustrating the paradoxical nature of liquidity. ?Chapters 1-3 would have made a very good qualitative monograph on liquidity — but it would be so small that you couldn’t charge $80+ for it.

Chapters 4-6 will only be useful to the mathematically inclined. ?I’m dubious that they even be useful then, because much of it is calculus, which does not do well with discontinuous events such as market panics. ?(You would have thought that the quants on Wall Street would have learned by now, but no…) ?Even if the models did work, there are simpler ways to see the same things, as I pointed out above.

As such, I really can’t recommend the book, and at $80+ the price is a lot more expensive than the free Monograph from the CFA Institute “The New Economics of Liquidity and Financial Frictions.” [PDF] ?Read that, not this, and save liquidity.

Quibbles

The book could have used a better editor. ?Too many typos in the introductory chapters.

Summary / Who Would Benefit from this Book

If you are a math nerd, and want to pay a lot of money to buy a book that I think will at least partially mislead you on liquidity risk, then this is the book for you. ?If you want to buy it, you can buy it here: Market Liquidity Risk.

Full disclosure:?I?received a?copy from a friendly?PR flack.

If you enter Amazon through my site, and you buy anything, I get a small commission.? This is my main source of blog revenue.? I prefer this to a ?tip jar? because I want you to get something you want, rather than merely giving me a tip.? Book reviews take time, particularly with the reading, which most book reviewers don?t do in full, and I typically do. (When I don?t, I mention that I scanned the book.? Also, I never use the data that the PR flacks send out.)

Most people buying at Amazon do not enter via a referring website.? Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.? Whether you buy at Amazon directly or enter via my site, your prices don?t change.

How Much is that Asset in the Window?

Posted on 8 September 2015 by David Merkel

Photo Credit: Kevin Dooley || At the Ice Museum, ALL of the assets are frozen!

This article is another experiment. Please bear with me.

Q: What is an asset worth?

A: An asset is worth whatever the highest bidder will pay for it at the time you offer it for sale.

Q: Come on, the value of an asset must be more enduring than that. ?You look at the balance sheets of corporations, and they don’t list their assets at sales prices.

A: That’s for a different purpose. ?We can’t get the prices of all assets to trade frequently. ?The economic world isn’t only about trading, it is about building objects, offering services… and really, it is about making people happier through service. ?Because the assets don’t trade regularly, they are entered onto the balance sheet at:

Cost, which is sometimes adjusted for cost and other things that are time-related, and subject to writedowns.
The value of the asset at its most recent sale date before the date of the statement
An estimated value calculated from sales of assets like it, meant to reflect the likely markets at the time of the statement — what might the price be in a deal between and un-coerced buyer and seller?

Anyway, values in financial statements are only indicative of aspects of value. ?Few investors use them in detail. ?Even value investors who use the detailed balance sheet values in their investment decisions make extensive adjustments to them to try to make them more realistic. ?Other value investors look at where the prices of similar companies that went private to try to estimate the value of public equities.

Certainly the same thing goes on with real estate. ?Realtors and appraisers come up with values of comparable properties, and make adjustments to try to estimate the value of the property in question. ?Much as realtors don’t like Zillow, it does the same thing just with a huge econometric model that factors in as much information as they have regarding the likely prices of residential real estate given the prices of the sparse number of sales that they have to work from.

Financial institutions regularly have to estimate values for variety of illiquid assets in a similar way. ?I’ve even been known to help with those efforts on occasion, though management teams have not always been grateful for that.

Q: What if it’s a bad day when I offer my asset for sale? ?Is my asset worth less simply because of transitory conditions?

A: Do you have to sell your asset that day or not?

Q: Why does that matter?

A: If you don’t need the money immediately, you could wait. ?You also don’t have to auction the asset if you think that hiring an expert come in and talk with a variety of motivated buyers could result in a better price after commissions. ?There are no guarantees of a better result there though.

The same problem exists on the stock market. ?If you want the the money now, issue a market order to sell the security, and you will get something close to the best price at that moment. ?That said, I never use market orders.

Q: Why don’t you use market orders?

A: I don’t want to be left at the mercy of those trading rapidly in the markets. ?I would rather set out a price that I think someone will transact at, and adjust it if need be. ?Nothing is guaranteed — a trade might not get done. ?But I won’t get caught in a “flash crash” type of scenario, or most other types of minor market manipulation.

Patience is a virtue in buying and selling, as is the option of walking away. ?If you seem to be a forced seller, buyers will lower their bids if you seem to be desperate. ?You may not notice this in liquid stocks, but in illiquid stocks and other illiquid assets, this is definitely a factor.

-==-=-=–=-==-=-=–=–=-==–=-=-=-=-=-=-=-=

That’s all for now. ?If anyone has any ideas on if, where, or how I should continue this piece, let me know in the comments, or send me an e-mail. ?Thanks for reading.

Book Review: Charlie Munger: The Complete Investor

Posted on 5 September 20156 September 2015 by David Merkel

This book is written by an interesting man about another interesting man. ?Tren Griffin writes a respectable blog called 25iq. ?His main topics are the theory of value investing, and what he has learned from bright investors and businessmen. ?One of his favorite businessmen/investors that he likes studying is Charlie Munger, and that’s why he wrote the book.

Why is Tren Griffin interesting, aside from his writing? ?Well, he solved a practical problem of his own once using the ideas of Munger and Buffett. ?As an executive at Microsoft, he had a large block of Microsoft stock during the dot-com bubble. ?His dilemma: should he sell his stock or not? ?After reading Munger particularly, he came up with a solution that I would endorse: he sold half of his holdings. ?A lot of good investing is getting around psychological barriers so that you are?happy with your results, and be able to sleep well at night. ?Selling half is never the optimal solution, but it is a good one amid uncertainty, and allows you to stop sitting on your hands amid danger.

A lot of what goes into the thought processes of Charlie Munger involves how investors let fear or greed get the better of them, and cease to think rationally. ?Learning these foibles has two advantages: you can try to train yourself to avoid these problems, and take advantage of the irrationality of others in business and investing.

In his book, Tren Griffin takes you through Munger’s thoughts on Value Investing. ?Particularly interesting to me was how the concept of Margin of Safety changed, and what role Munger played in its development. ?The key change was noting that businesses differ in quality, especially as to how long they can maintain above average returns on their invested capital, and how much of their profits would be free to be reinvested in the business. ?An ideal business would be a natural monopoly with a high return on capital, and a need for continued capital investment somewhat less than its profits.

Tren Griffin?also introduces you to the mental models of Munger. ?Strong generalist knowledge in a wide number of areas can aid making business and investment decisions. ?One drawback is that many of the mental models are clear and adequately described — the ones on human psychology. ?The rest are more vague, and seem to be?what a true liberal arts education should be, including math and science. ?Munger is a lifelong learner, and given how much the world changes, if you want to be competitive, you have to continually update your knowledge.

For those who are familiar with the way that Munger thinks, this is old hat. ?But for those that are new to it, this book is an excellent introduction, and is systematic in?a slim 150+ small pages of information. ?On that basis, I recommend the book strongly.

But, if you’re still not sure whether you would like the book or not, or whether it would be a good book for a friend of yours, you have an easy way to help you decide. ?Just visit the author’s blog, and look at the topics page. ?Scroll down and find the topic “Charlie Munger.” ?Of the nine articles presently there, pick two of them and read them. ?If you like them, you will like the book.

Quibbles

From my past dealings with authors, I know they don’t always control the title of the book, but this book is half about Munger and half about value investing generally, particularly the version of value investing practiced at Berkshire Hathaway. ?There are ample quotations from Buffett and other value investors along with more from Munger. ?If I had been structuring the book, I would have made it entirely about Munger, and might have included a biography if the book had not been long enough.

The appendices are a good example of that, in that they are less about what Munger thinks, and more about the way Berkshire Hathaway views value investing. ?The last appendix doesn’t seem to mention Munger at all.

Summary / Who Would Benefit from this Book

If you’ve read a lot of Munger, this book will likely not benefit you. ?If you are new to the thoughts of Charlie Munger, or want aid in clarifying his thoughts into a system, this book will help do that. ?If you want to buy it, you can buy it here: Charlie Munger: The Complete Investor.

Full disclosure:?I?received a?copy from a friendly?PR flack.

When to Double Down

Posted on 5 September 2015 by David Merkel

Here is a recent question that I got from a reader:

I have a question for you that I don?t think you?ve addressed in your blog. Do you ever double down on something that has dropped significantly beyond portfolio rule VII?s rebalancing requirements and you see no reason to doubt your original thesis? Or do you almost always stick to rule VII? Just curious.

Portfolio rule seven is:

Rebalance the portfolio whenever a stock gets more than 20% away from its target weight. Run a largely equal-weighted portfolio because it is genuinely difficult to tell what idea is the best. Keep about 30-40 names for diversification purposes.

This rule is meant to control arrogance and encourage patience. ?I learned this lesson the hard way when I was younger, and I would double down on investments that had fallen significantly in value. ?It was never in hope of getting the whole position back to even, but that the incremental money had better odds of succeeding than other potential uses of the money.

Well, that would be true if your thesis is right, against a market that genuinely does not understand. ?It also requires that you have the patience to hold the position through the decline.

When I was younger, I was less cautious, and so by doubling down in situations where I did not do my homework well enough, I lost a decent amount of money. ?If you want to read those stories, they are found in my Learning from the Past series.

Now, since I set up the eight rules, I have doubled down maybe 5-6 times over the last 15 years. ?In other words, I haven’t done it often. ?I?turn a single-weight stock into a double-weight stock if I know:

The position is utterly safe, it can’t go broke
The valuation is stupid cheap
I have a distinct edge in understanding the company, and after significant review I conclude that I can’t lose

Each of those 5-6 times I have made significant money, with no losers. ?You might ask, “Well, why not do that only, and all the time?” ?I would be in cash most of the time, then. ?I make decent money on the rest of my stocks as well on average.

The distinct edge usually falls into the bucket of the market sells off an entire industry, not realizing there are some stocks in the industry that aren’t subject to much of the risk in question. ?It could be as simple as refiners getting sold off when oil prices fall, even though they aren’t affected much by oil prices. ?Or, it could be knowing which insurance companies are safe in the midst of a crisis. ?Regardless, it has to be a big edge, and a big valuation gap, and safe.

The Sense of Rule Seven

Rule Seven has been the rule that has most protected the downside of my portfolio while enhancing the upside. ?The two major reasons for this is that a falling stock triggers a thorough review, and that if I do add to my position, I do so in a moderate and measured way, and not out of any emotion. ?It’s a business, it is not a gamble per se.

As a result I have had very few major losses since implementing the portfolio rules. ?I probably have one more article to add to the “Learning from the Past Series,” and the number of severe losses over the past 15 years is around a?half dozen out of 200+ stocks that I invested in.

Summary

Doubling down is too bold of a strategy, and too prone for abuse. ?It should only be done when the investor has a large edge, cheap valuation, and safety. ?Rule Seven allows for moderate?purchases under ordinary conditions, and leads to risk reductions when position reviews highlight errors. ?If errors are eliminated, Rule Seven will boost returns over time in a modest way, and reduce risk as well.

Plan and Act, Don’t React

Posted on 2 September 2015 by David Merkel

An investor can and should learn from the past. ?He should never react to the recent past. ?Why? ?The past can’t be changed, but it can be known. ?Reacting to the recent past leads investors into the valleys of greed and regret — good investments missed, bad investments incurred.

We’ve been in a relatively volatile environment for the last two weeks or so. ?Markets are down, with a lot of noise over China, and slowing global growth. ?Boo!

The markets were too complacent for too long, and valuations were/are higher than they should be, given current earnings, growth prospects and corporate bond yields. ?It’s not the best environment for stocks given those longer-term valuation factors, but guess what? ?The market often ignores those until a crisis hits.

The FOMC is going to tighten monetary policy soon. ?Boo!

The things that people are taking on as worries rarely produce large crises. ?They could mark stocks down 20-30% from the peak, producing a bear market, but they are unlikely of themselves to produce something similar to 2000-2 or 2008-9.

Let’s think about a few things supporting valuations and suppressing yields at present. ?The overarching demographic trend in the market leads to a fairly consistent bid for risky assets. ?It would take a lot to derail that bid, though that has happened twice in the last 15 years. ?Ask yourself, do we face some significant imbalance where the banks could be impaired??I don’t see it at present. ?Is a major sector like information technology or healthcare dramatically overvalued? ?Maybe a little overvalued, but not a lot in relative terms.

There are major elections coming up next year, and a group of politicians harmful to the market will be elected. ?This is a bad part of the Presidential Cycle. ?Boo!

Take a step back, and ask how you would want your portfolio positioned for a moderate pullback, where you can’t predict how long it will take or last. ?Also ask how you would like to be positioned for the market to return to its recent highs over the next year. ?Come up with your own estimates of likelihood for these scenarios, and others that you might imagine.

We work in a fog. ?We don’t know the future at all, but we can take actions to affect it, and our investing results. ?The trouble is, we can adjust our risk profile, but our ability to know when it is wise to take more or less risk is poor, except perhaps at market extremes. ?Even then, we don’t act, because we drink the Kool-aid in those ebullient or depressed environments. ?We often know what we should do at the extremes, but we don’t listen. ?There is a failure of the will.

This is a bad season of the year. ?September and October are particularly bad months. ?Boo!

I often say that there is always enough time to panic. ?Well, let me modify that: there’s also always enough time to plan. ?But what will you take as inputs to your plan? ?Look at your time horizon, and ask what investment factors will persistently change over that horizon. ?There are factors that will change, but can you see any that are significant enough for you to notice, and obscure enough that much of the rest of the market has missed it?

Yeah, that’s tough to do. ?So perhaps be modest in your risk positioning, and invest with a margin of safety for the intermediate-to-long-term, recognizing that in most cases, the worst case scenario does not persist. ?The Great Depression ended. ?So did the ’70s. ?Valuations are higher now than in 2007. ?(Tsst… Boo!) ?The crisis in 2008-9 did not persist.

That doesn’t mean a crisis could not persist, just that it is unlikely. ?Capitalist systems are very good at dealing with economic volatility, even amid moderate socialism. ?Go ahead and ask, “Will we become like Greece? ?Argentina? ?Venezuela? ?Russia? ?Spain? ?Etc?” ?Boo!

It would take a lot to get us to the economic conditions of any of those places. ?Thus I would say it is reasonable to take moderate risk in this environment if your time horizon and stomach/sleep allow for it. ?That doesn’t mean you won’t go through a bear market in the future, but it will be unlikely for that bear market to last beyond two years, and even less likely a decade.

The Surprise Dividend

Posted on 1 September 20152 September 2015 by David Merkel

This is just a “what if” piece. If one of my readers knows better than me, leave a comment, or email me. Thanks.

The Surprise Dividend

Imagine one day in 2019 that your favorite dividend-paying stock made the following announcement:

Dear Shareholder,

As you may know, we currently pay a dividend of $2/year to holders of our common stock for each share they hold. ?In this current climate where there is uncertainty over whether dividends will be cut at some companies, we would like to guarantee the current payout, and give you more.

We are replacing the current dividend and declaring a special payout?today — an unsecured perpetual junior subordinated bond that will pay 80?cents quarterly per current share, payable to all current shareholders as of June 1st, 2019. ?It will be eligible to trade separately under the ticker [TICKER]. ?You are free to sell this income stream for a current gain, or you can continue to receive this income in perpetuity, as will any future holder of this bond.

Why are we doing this? ?The Total Revenue And Safe Harbor Act of 2018 repealed special treatment of dividends, but interest is still tax-deductible to us as a corporation. ?Much as we like the flexibility of dividends, our cash flow is more than sufficient, and can handle a higher payout. ?This higher payout?is possible partially because this is an interest payment, and we get to deduct the payment from taxable income. ?With our current corporate tax rate of 35%, the effective cost of the new dividend to the corporation is $2.08 per current share.

Many of our shareholders are not taxable, or have taxes deferred. ?Still others are retirees who are in lower personal tax brackets. ?We expect that some current shareholders in higher tax brackets will choose to sell their bonds. ?We would not be surprised to find life insurance companies as willing buyers, given our high credit rating, and their need for long bonds as investments.

Though in the near-term, we will not pay a dividend, that does not mean we will never pay a dividend again. ?We will review our payout?policy regularly, and make changes as we see best. ?It is also possible that future shareholders could see further issuance of these securities if?our reliable excess cash flow grows.

As always, we welcome your inquiries to our Investor Relations Department. ?Please be aware that this does not constitute tax advice, nor will we provide that to you. ?Please give your tax questions to your own personal tax adviser.

Many thanks for being one of our shareholders. ?We hope you prosper in 2019 and beyond.

I left aside the argument that now shareholders could choose their own income preference, and also that the income from a junior subordinated bond could survive bankruptcy (though unlikely), and could control the company post-bankruptcy (also unlikely). ?Mentions of bankruptcy don’t travel well, even in vague terms.

I also did not mention that the package of the junior bond and the post-dividend stock would likely trade at a higher price post-event. ?Might some activist investors try some more severe proposals of?this sort?

Your thoughts on this proposal are welcome. ?I can’t think of any firm that has done something like this in the past. ?Might they do it in the future?

We Still Have a Buck in the Till; We’re Solvent!

Posted on 30 August 2015 by David Merkel

Imagine that you are in the position of a high cost crude oil producer that has a lot of debt to service. ?The price that you can sell your oil for is high enough?that you make some?cash over your variable cost. ?The price is low enough that you are not recouping the cost of what you paid to buy the right to develop the oil, the development cost, and cost of equity capital employed.

In this awkward situation you continue to produce oil, because it may keep you from defaulting on your debts, even though you are not earning what is needed to justify the GAAP book value of your firm. ?You’re destroying value by producing, but because of the debt, you don’t have the option of waiting because not surviving loses more money than pumping oil and seeing if you can survive.

Where there is life, there is hope. ?Who knows, one of three?things could “go right:”

Enough competitors could fail such that global industry capacity reduces and prices rise.
Demand for oil could rise because it is cheap, leading prices to rise.
You could get bought out by a more solvent competitor with a longer time horizon, who sees the assets as eventually valuable.

Trouble is with #1, you could fail first. ?With #2, the process is slow, and who knows how much the Saudis will pump. ?With #3, the price that an acquirer could pay might not be enough for shareholders, or worse, they could buy out your competitors and not you, leaving you in a worse competitive position.

One more thought: think of the Saudis, the Venezuelans, etc… all of the national oil companies. ?They’re not in all that different a spot than you are. ?They need cash to fund government programs or they may face unrest. ?For some like the Saudis, who assets in reserve, the odds are lower. ?For the Venezuelans, who have had their economy destroyed by the politics of Chavez, the odds are a lot higher.

There will be failures among energy producers, and that could include nations. ?Failures with?each will be temporary as debts get worked through/compromised and new management takes over, and high cost supply gets shut down. ?The question is: who will fail and who won’t. ?The job of the hypothetical firm that I posited at the beginning of this article is to survive until prices rise. ?What will a survivor look like?

Relatively high contribution margins (Price – variable cost per barrel)
Relatively little debt
Debt has long maturities and/or low coupons.

Now, I’m going to give you 40% of the answer here… I’m still working on the contribution margin question, but I can give you a useful measure regarding debt. ?My summary measure is total debt as a ratio of market capitalization. ?It’s crude, but I think it is a good first pass on debt stress, because the market capitalization figures carry an implicit estimate of the probability of bankruptcy.

Anyway here’s a list of all of the oil companies in the database that have debt greater than their market cap:

Company	Country	ticker	Mkt cap	Debt / Market Cap
Energy XXI Ltd	Bermuda	EXXI	171	26.93
SandRidge Energy Inc.	United States	SD	264	16.63
Comstock Resources Inc	United States	CRK	146	9.45
Linn Energy LLC	United States	LINE	1,172	8.81
EXCO Resources Inc	United States	XCO	213	7.2
Cosan Limited(USA)	Brazil	CZZ	1,015	6.34
W&T Offshore, Inc.	United States	WTI	245	6
Halcon Resources Corp	United States	HK	620	5.89
BreitBurn Energy Partners L.P.	United States	BBEP	614	5.05
Magnum Hunter Resources Corp	United States	MHR	188	5.05
California Resources Corp	United States	CRC	1,325	4.92
Sanchez Energy Corp	United States	SN	368	4.74
Crestwood Equity Partners LP	United States	CEQP	543	4.64
Rex Energy Corporation	United States	REXX	171	4.51
Penn West Petroleum Ltd (USA)	Canada	PWE	403	4.19
Atlas Resource Partners, L.P.	United States	ARP	365	4.09
Gastar Exploration Inc	United States	GST	108	3.8
Petroleo Brasileiro Petrobras	Brazil	PBR	35,748	3.71
Stone Energy Corporation	United States	SGY	292	3.59
Bill Barrett Corporation	United States	BBG	252	3.19
EP Energy Corp	United States	EPE	1,552	3.15
Memorial Production Partners L	United States	MEMP	599	3.05
Premier Oil PLC (ADR)	United Kingdom	PMOIY	828	2.95
Triangle Petroleum Corporation	United States	TPLM	286	2.88
Ultra Petroleum Corp.	United States	UPL	1,281	2.68
Bonanza Creek Energy Inc	United States	BCEI	333	2.55
Northern Oil & Gas, Inc.	United States	NOG	359	2.47
Denbury Resources Inc.	United States	DNR	1,479	2.37
Jones Energy Inc	United States	JONE	354	2.36
Chesapeake Energy Corporation	United States	CHK	4,917	2.35
Vanguard Natural Resources, LL	United States	VNR	833	2.27
LRR Energy LP	United States	LRE	128	2.23
Pengrowth Energy Corp (USA)	Canada	PGH	705	2.21
Legacy Reserves LP	United States	LGCY	461	2.1
Aegean Marine Petroleum Networ	Greece	ANW	391	1.85
GeoPark Ltd	Chile	GPRK	202	1.8
Mitsui & Co Ltd (ADR)	Japan	MITSY	23,727	1.74
Oasis Petroleum Inc.	United States	OAS	1,390	1.69
Santos Ltd (ADR)	Australia	SSLTY	3,813	1.59
Whiting Petroleum Corp	United States	WLL	3,593	1.46
Midcoast Energy Partners LP	United States	MEP	558	1.45
Paramount Resources Ltd (USA)	Canada	PRMRF	1,006	1.35
Encana Corporation (USA)	Canada	ECA	5,944	1.33
Clayton Williams Energy, Inc.	United States	CWEI	597	1.25
Clean Energy Fuels Corp	United States	CLNE	468	1.23
EV Energy Partners, L.P.	United States	EVEP	405	1.23
WPX Energy Inc	United States	WPX	1,660	1.2
Baytex Energy Corp (USA)	Canada	BTE	1,068	1.19
ONEOK, Inc.	United States	OKE	7,453	1.18
SunCoke Energy Partners LP	United States	SXCP	505	1.18
TransAtlantic Petroleum Ltd	United States	TAT	126	1.13
Global Partners LP	United States	GLP	1,071	1.12
NGL Energy Partners LP	United States	NGL	2,659	1.12
Sprague Resources LP	United States	SRLP	495	1.11
Amyris Inc	United States	AMRS	266	1.07
Sunoco LP	United States	SUN	1,605	1.06
SM Energy Co	United States	SM	2,360	1.05
Solazyme Inc	United States	SZYM	202	1

This isn’t a complete analysis by any means. Personally, I would be skeptical of holding any company twice as much debt as market cap without a significant analysis. ?Have at it your own way, but be careful, there will be a lot of stress on oil companies with high debt.

The Importance of Your Time Horizon

Posted on 29 August 2015 by David Merkel

Photo Credit: Dr. Wendy Longo || This horizon is distant... — Photo Credit: Dr. Wendy Longo || This horizon is distant…

I ran across two interesting articles today:

Volatility Doesn’t Equal Loss?Unless You Sell?from Oppenheimer Funds, and
Buying the Dips Doesn?t Work for Everyone?by the estimable Jason Zweig.

Both articles are exercises in understanding the time horizon over which you invest. ?If you are older, you may not have the time to recover from market shortfalls, so advice to buy dips may sound hollow when you are nearer to drawing on your assets.

Thus the idea that volatility, presumably negative, doesn’t hurt unless you sell. ?Some people don’t have much choice in the matter. ?They have retired, and they have a lump sum of money that they are managing for long-term income. ?No more money is going in, money is only going out. ?What can you do?

You have to plan before volatility strikes. ?My equity only clients had 14% cash before the recent volatility hit. ?Over the past week I opportunistically brought that down to 10% in names that I would like to own even if the “crisis” deepened. ?That flexibility was built into my management. ?(If the market recovers enough, I will rebuild the buffer. ?Around 1300 on the S&P, I would put all cash to work, and move to the alternative portfolio management strategy where I sell the most marginal ideas one at a time to raise cash and reinvest into the best ideas.)

If an older investor would be?hurt by a drawdown in the stock market, he needs to invest less in stocks now, even if that means having a lower income on average over the longer-term. ?With a higher level of bonds in the portfolio, he could more than?proportionately draw down on bonds during a crisis, which would rebalance his portfolio. ?If and when the stock market recovered, for a time, he could draw on has stock positions more than proportionately then. ?That also would rebalance the portfolio.

Again, plans like that need to be made in advance. ?If you have no plans for defense, you will lose most wars.

One more note: often when we talk about time horizon, it sounds like we are talking about a single future point in time. ?When the time for converting assets to cash is far distant, using a single point may be a decent approximation. ?When the time for converting assets to cash is near, it must be viewed as a stream of payments, and whatever scenario testing, (quasi)?Monte Carlo simulations, and sensitivity analyses are done must reflect that.

Many different scenarios may have the same average rate of return, but the ones with early losses and late gains are pure poison to the person trying to manage a lump sum in retirement. ?The same would apply to an early spike in inflation rates followed by deflation.

The time to plan is now for all contingencies, and please realize that this is an art and not a science, so if someone comes to you with glitzy simulation?analyses, ask them to run the following scenarios: run every 30-year period back as far as the data goes. ?If it doesn’t include the Great Depression, it is not realistic enough. ?Run them forwards, backwards, upside-down forwards, and upside-down backwards. ?(For the upside-down scenarios normalize the return levels to the right side up levels.) ?The idea here is to use real volatility levels in the analyses, because reality is almost always more volatile than models using normal distributions. ?History is meaner, much meaner than models, and will likely be meaner in the future… we just don’t know how it will be meaner.

You will then be surprised at how much caution the models will indicate, and hopefully those who can will save more, run safer asset allocations, and plan to withdraw less over time. ?Reality is a lot more stingy than the models of most financial Dr. Feelgoods out there.

One more note: and I know how to model this, but most won’t — in the Great Depression, the returns after 1931 weren’t bad. ?Trouble is, few were able to take advantage of them because they had already drawn down on their investments. ?The many bankruptcies meant there was a smaller market available to invest in, so the dollar-weighted returns in the Great Depression were lower than the buy-and-hold returns. ?They had to be lower, because many people could not hold their investments for the eventual recovery. ?Part of that was margin loans, part of it was liquidating assets to help tide over unemployment.

It would be wonky, but simulation models would have to have an uptick in need for withdrawals at the very time that markets are low. ?That’s not all that much different than some had to do in the recent financial crisis. ?Now, who is willing to throw *that* into financial planning models?

The simple answer is to be more conservative. ?Expect less from your investments, and maybe you will get positive surprises. ?Better that than being negatively surprised when older, when flexibility is limited.

When to Deploy Capital

Posted on 27 August 201527 August 2015 by David Merkel

Photo Credit: edkohler || Buy Now and smile!

One of my clients asked me what I think is a hard question: When should I deploy capital? ?I?ll try to answer that here.

There are three?main things to consider in using cash to buy or sell assets:

What is your time horizon? ?When will you likely need the money for spending purposes?
How promising is the asset in question? ?What do you think it might return vs alternatives, including holding cash?
How safe is the asset in question? ?Will it survive to the end of your time horizon under almost all circumstances and at least preserve value while you wait?

Other questions like ?Should I dollar cost average, or invest the lump?? are lesser questions, because what will make the most difference in ultimate returns comes from ?the above three questions. ?Putting it another way, the?results of dollar cost averaging depend on returns after you put in the last dollar of the lump, as does investing the lump sum all at once.

Thinking about price momentum and mean-reversion are also lesser matters, because if your time horizon is a long one, the initial results will have a modest effect on the ultimate results.

Now, if you care about price momentum, you may as well ignore the rest of the piece, and start trading in and out with the waves of the market, assuming you can do it. ?If you care about mean reversion, you can wait in cash until we get ?the mother of all selloffs? and then invest. ?That has its problems as well: what?s a big enough selloff? ?There are a lot of bears waiting for rock bottom valuations, but the promised bargain valuations don?t materialize because others invest at higher prices than you would, and the prices?never get as low as you would like. ?Ask?John Hussman.

Investing has to be done on a ?good enough? basis. ?The optimal return in hindsight is never achieved. ?Thus, at least for value investors like me, we focus on what we can figure out:

How long can I set aside this capital?
Is this a promising investment at a relatively attractive price?
Do I have a margin of safety buying this?

Those are the same questions as the first three, just phrased differently.

Now, I?m not saying that there is never a time to sit on cash, but decisions like that are typically limited to times where valuations are utterly nuts, like 1964-5, 1968, 1972, 1999-2000 ? basically parts of the go-go years and the dot-com bubble. ?Those situations don?t last more than a decade, and are typically much shorter.

Beyond that, if you have the capital to spare, and the opportunity is safe and cheap, then deploy the capital. ?You?ll never get it perfect. ?The price may fall after you buy. ?Those are the breaks. ?If that really bothers you, then maybe?do half?of what you would ultimately do, but set a time limit for investment of the other half. ?Remember, the opposite can happen, and the price could run away from you.

A better idea might show up later. ?If there is enough liquidity,?trade into the new idea.

Since perfection is not achievable, if you have something good enough, I recommend that you execute and deploy the capital. ?Over the long haul, given relative peace, the advantage belongs to the one who is invested.

If you still wonder about this question you can read the following two articles:

In the end, there is no perfect answer, so if the situation is good enough, give it your best shot.