PCM Newsletter
Our quarterly newsletter provides market commentary, portfolio updates, and insights into our investment thinking. Browse the archives below.
December 2010
+
December 4, 2010
| Range of Returns* | November |
YTD |
| Custom Accounts: | (.08% - 3.2%) |
(1.0%) - 21.7% |
| Income Accounts: | 1.7% - 2.3% |
9.6% - 22.0% |
| Short Accounts: | inactive |
inactive |
| S&P 500: | -0.2% |
5.9% |
*Returns are net of fees and commissions and the
S&P 500's return excludes dividend reinvestment. All numbers are unaudited.
The risk of loss always exists and past results are not necessarily indicative of future results.
Strengthening dollar doesn't derail gold
The US dollar has had a reprieve as the Euro has become the weak link among the major currencies. This relative strength hasn't hurt gold, which suggests to me that gold isn't just an anti-dollar play, as some would believe. My position is that gold is a good hedge against all kinds of uncertainty, fiat money, potential inflation (or deflation), and the integrity of the world's financial system.
In a slightly more cynical fashion, Floyd Norris wrote in a NY Times article ("Gold Fever: Pondering the Causes" Nov. 26) "You are buying gold because it is the alternative to this collection of stupid politicians around the world."
As to gold fundamentals, a recent FT article ("China Sees Gold Imports Surge as Investors Search for Safe Havens" Dec. 3) stated that China imported more than 209 tonnes in the first 10 months of this year "a fivefold increase on an estimate of 45 tonnes last year." In other words, demand is strong and still growing. I would be concerned if I saw supplies to match that demand, but so far that isn't happening.
Most portfolios also own silver, which has gained 65% this year. It has gone from being cheap relative to gold to being fairly valued based on the historical gold/silver relationship. I don't expect silver to outperform gold dramatically from these levels, but I still like the precious metals complex and expect to hold both gold and silver. In addition, several portfolios own Harry Winston Diamonds ("HWD") and I'd like to buy more.
Sentiment has been a headwind
After the FOMC's Nov. 3 announcement of QE2 and Bernanke's comment that the economy would benefit from higher equity prices, call demand more than doubled to 3.9mm on the 4th from roughly 1.9mm on the 1st and 2nd. Another 3.2mm calls were purchased Friday the 5th. The put/call ("P/C") ratio on these days was roughly .7, whereas it averages .9. This overwhelming call demand represented too much optimism, and contributed to the S&P's poor performance (-3.7%) for the balance of November. Anyone who purchased November calls on the basis of Bernanke's remarks saw their investment expire worthless; the only beneficiaries were the sellers of the calls, the big investment firms.
mention the P/C ratio because in November it was such an accurate precursor to the change in market direction. There are other sentiment indicators as well, and a variety of valuation metrics, liquidity measurements and so forth. None of them is always reliable, but strategists sometimes weave an investment thesis based on their interpretation of what they are collectively saying.
During November the S&P 500 futures tested the low end (1170-1175) of their recent range six times and held each time. Furthermore, I would say that economic data and corporate profits have been better than expected, with the exception of Friday's employment report. As long as sentiment doesn't revert back to that overly optimistic point, I would think there is a good chance that early December's gains will hold and the S&P 500 will finish the year at or possibly above it's current level. However, if the P/C ratio revisits the .65-.7 range for more than a couple days I would think that the year's high is in.
Regardless, Peattie Capital's approach remains the same, and has been effective in this environment. We look to be involved in the right securities at the right price, and from time to time, when we feel it is appropriate, we make tactical adjustments to portfolios to protect overall wealth.
More Fed Buying?
I mentioned last month that I was suspicious that the Federal Reserve has been involved in the equity markets by buying S&P futures heavily very early in the morning (before the market's 9:30 open) on certain days. On these "Fed days" the S&P opens sharply higher, has an early morning low, and finishes the day with gains from 1-2%. Not surprisingly, the recent GM IPO came on such a day. This has now happened 12 times since August, including the first two days of December, although performance on these days could be ascribed to portfolio rebalancing. I don't recall ever seeing so many days that were straight up, with no intent to sell off at any time during the session.
As I've said, I'd rather see a market that pushes upwards throughout the day and closes at its high as a result of real buying. For the past few months, however, more than half the gains are taking place at the open (source: Jerry Hegarty Newsletters, December 3, 2010), which is somewhat troubling to me.
Portfolio Activity
I've added shares of Joy Global Manufacturing ("JOYG") after Caterpillar announced a takeover of Bucyrus ("BUCY"), its closest competitor. I've also added shares of Westell Technologies ("WSTL") which provides critical hardware at the "demarcation point", the point at which cell towers and land cables meet. Tyco ("TYC") recently purchased a competitor of WSTL at 18x forward earnings estimates, and WSTL trades at roughly seven times. To me this looks like a cheap way to participate in the exploding market for mobile data and applications. When I saw that Goldman Sachs downgraded Seadrill ("SDRL") to "sell" this week I got excited about being able to buy more on the cheap. Alas, the shares are up over 3% since the downgrade so that opportunity hasn't presented itself, at least not yet.
Please feel free to contact me with any questions or comments.
November 2010
+
November 4, 2010
I continue to wrestle with how to present results for Peattie Capital, and have come up with the above table, which hopefully is a reasonable solution. All returns are net of fees and commissions and are unaudited.
Positions in "custom accounts" vary from client to client depending on client specific goals and constraints, and so the range of returns can be broad. "Income accounts" are very similar to one another, differing only in weightings and activity, which account for the slight difference in returns. "Short accounts" will consist mostly of the same names also and I expect their returns to be tightly bunched as well.
I remain optimistic about the income accounts, as the fundamental drivers of their holdings are still in place. Additionally, if dividend tax rates rise (granted, less likely given the election results), the relative advantage of Master Limited Partnerships will increase, as most of the dividends MLPs pay are a "return of capital" and only a small portion of the payout (15%-20%) is taxable. Holders of MLPs enjoy yields ranging from 5%-9%, and keep most of that for themselves.
In addition to being tax advantaged, MLP's actively grow their operations and frequently raise their distributions. Our largest income position is LINN Energy ("LINE"), which we started buying in late 2008. Before dividends, the units have appreciated 130%. By way of reminder, PCM charges an annual fee of 0.65% (65 basis points) on income accounts.
One potential headwind for MLPs is rising interest rates, but rates are so low that they will need to rise significantly before they present a reasonable alternative. This bears watching, but I don't see rising rates as an immediate threat. That said, my belief is that bonds are at/near the end of an enormous bull run, which started back around 1980. Why else would Goldman Sachs borrow 50 year money? Over the next decade I would expect a host of other investments to outperform the 10-year US treasury note, which currently yields 2.6%.
KVH Industries.....again
Last month I said that I expected continued volatility in KVH Industries ("KVHI"), our largest single position. After the company presented a mildly disappointing outlook for Q4 last week, the shares dropped nearly 15%. However, after visiting with the CFO at the company's offices Monday, I am convinced that the core product is rolling out beautifully. KVHI is now competing for commercial orders which could be "up to the size of the Coast Guard order," which was for 216 ships. I am hopeful that there will be announcements about significant commercial wins over the next few quarters, and when that happens, I expect considerable upside to the shares.
Several of PCM's biggest positions are small and mid cap names which can be volatile, but I believe they will be big winners and I expect to hold them.
A busy week
This week we have had first of the month inflows, elections, and FOMC minutes, and on Friday we will get the monthly unemployment report. More importantly, we continue to see reasonably good earnings reports, and even better, the names in PCM portfolios have posted good results (KVHI notwithstanding). I am not in the business of predicting short-term market direction, but rather, as I've said many times, finding the right situations and being involved at the right prices.
That said, several strategists I follow have pointed out the similarities between 2010 and 1994, when the GOP also made a strong showing in the midterm elections. In that instance, there were a few weeks of indigestion, with the market giving back about 6% over the subsequent month. Then the S&P 500 added 32% over the next 10 months.
Additionally, we are now in the the strongest six month period of the calendar, and the third year of a Presidential term tends to be the strongest for the markets. I am reluctant to make any major decisions based on these factors, but I think it's important to know the environment. I have trimmed a bit, especially in IRA accounts, and may do a little pruning and hedging around the edges of other portfolios as well. But for the most part I am finding things I want to own and buying them at prices I'm comfortable paying. As a result, most accounts are close to fully invested.
No one knows how QE2 will play out, but it is slightly higher than what the market expected, and I would think that US dollar weakness will continue. PCM owns many names that have international operations, which is important for two reasons. First, other areas of the world are growing more rapidly than the US, and second, there will be a currency tailwind when international results are translated back into US dollars for reporting purposes.
A weaker US dollar is also one of the factors driving precious metals and other commodities, and I expect to hold our significant positions in gold and silver.
Oil and Energy
PCM portfolios own several energy names, and so I paid attention to the Saudi Arabian oil minister's recent comment that he was happy with oil prices between $70 and $90, raising the high end of the range from $80. Whether this is to compensate for a weakening dollar or some other reason I don't know.
My thinking with regards to oil and energy is threefold: 1) relying solely on US storage data as an investment guide is a mistake; 2) oil demand in developing nations is growing rapidly; 3) OPEC's spare capacity could dwindle more quickly than the market expects.
In addition to the Seadrill ("SDRL") I mentioned a couple months ago, I also own Schlumberger ("SLB"). Several executives recently exercised options and held the shares, which I take as a bullish indicator. Most recently I began buying Knightsbridge Tankers ("VLCCF") which has four double hull vessels to transport oil internationally. VLCCF sold off after announcing a secondary offering, and has subsequently rebounded strongly. VLCCF shares yield 9%, and I bought them for both income and custom accounts.
Can the equity markets be manipulated?
Why not? Historically the Federal Reserve has actively bought or sold fixed income securities in an effort to add or drain liquidity in the bond markets. This has been a very common tool for the Fed, which is usually used for technical reasons, that is, to maintain the appropriate liquidity in the system to hit their targeted Fed Funds rate. So why couldn't they buy equities or equity futures?
On balance, I would prefer to see equity markets that overcome early or mid day weakness and rally into the close, based on persistent demand. This has decidedly not been the case over the past few months, during which time about half the gains have come in overnight sessions which then led to days when the markets opened higher, never saw the red, and closed with solid gains. According to Jerry Hegarty (morning comments November 4), this is the antithesis of a true bull market, which would see about 45% of the market's gains takes place in the final hour. Regardless, it seems that we are headed for higher equity prices, at least through year end.
Miscellaneous
Last year Peattie Capital Management adopted the tag line "Invested in the Individual" to demonstrate the personal aspect of my approach and to emphasize that I manage separate accounts. I applied for the trademark rights to the phrase, and recently received them. Note the trademark protection in the purple bar above.
Please feel free to contact me with any questions or comments.
| Range of Returns | October |
YTD |
| Custom Accounts: | 1.3% - 11.7% |
0.3% - 20.8% |
| Income Accounts: | 3.5% - 4.4% |
17.6% - 19.3% |
| Short Accounts: | inactive |
inactive |
| S&P 500: | 3.6% |
6.1% |
*Returns are net of fees and commissions and the
S&P 500's return excludes dividend reinvestment. All numbers are unaudited.
The risk of loss always exists and past results are not necessarily indicative of future results.
I continue to wrestle with how to present results for Peattie Capital, and have come up with the above table, which hopefully is a reasonable solution. All returns are net of fees and commissions and are unaudited.
Positions in "custom accounts" vary from client to client depending on client specific goals and constraints, and so the range of returns can be broad. "Income accounts" are very similar to one another, differing only in weightings and activity, which account for the slight difference in returns. "Short accounts" will consist mostly of the same names also and I expect their returns to be tightly bunched as well.
I remain optimistic about the income accounts, as the fundamental drivers of their holdings are still in place. Additionally, if dividend tax rates rise (granted, less likely given the election results), the relative advantage of Master Limited Partnerships will increase, as most of the dividends MLPs pay are a "return of capital" and only a small portion of the payout (15%-20%) is taxable. Holders of MLPs enjoy yields ranging from 5%-9%, and keep most of that for themselves.
In addition to being tax advantaged, MLP's actively grow their operations and frequently raise their distributions. Our largest income position is LINN Energy ("LINE"), which we started buying in late 2008. Before dividends, the units have appreciated 130%. By way of reminder, PCM charges an annual fee of 0.65% (65 basis points) on income accounts.
One potential headwind for MLPs is rising interest rates, but rates are so low that they will need to rise significantly before they present a reasonable alternative. This bears watching, but I don't see rising rates as an immediate threat. That said, my belief is that bonds are at/near the end of an enormous bull run, which started back around 1980. Why else would Goldman Sachs borrow 50 year money? Over the next decade I would expect a host of other investments to outperform the 10-year US treasury note, which currently yields 2.6%.
KVH Industries.....again
Last month I said that I expected continued volatility in KVH Industries ("KVHI"), our largest single position. After the company presented a mildly disappointing outlook for Q4 last week, the shares dropped nearly 15%. However, after visiting with the CFO at the company's offices Monday, I am convinced that the core product is rolling out beautifully. KVHI is now competing for commercial orders which could be "up to the size of the Coast Guard order," which was for 216 ships. I am hopeful that there will be announcements about significant commercial wins over the next few quarters, and when that happens, I expect considerable upside to the shares.
Several of PCM's biggest positions are small and mid cap names which can be volatile, but I believe they will be big winners and I expect to hold them.
A busy week
This week we have had first of the month inflows, elections, and FOMC minutes, and on Friday we will get the monthly unemployment report. More importantly, we continue to see reasonably good earnings reports, and even better, the names in PCM portfolios have posted good results (KVHI notwithstanding). I am not in the business of predicting short-term market direction, but rather, as I've said many times, finding the right situations and being involved at the right prices.
That said, several strategists I follow have pointed out the similarities between 2010 and 1994, when the GOP also made a strong showing in the midterm elections. In that instance, there were a few weeks of indigestion, with the market giving back about 6% over the subsequent month. Then the S&P 500 added 32% over the next 10 months.
Additionally, we are now in the the strongest six month period of the calendar, and the third year of a Presidential term tends to be the strongest for the markets. I am reluctant to make any major decisions based on these factors, but I think it's important to know the environment. I have trimmed a bit, especially in IRA accounts, and may do a little pruning and hedging around the edges of other portfolios as well. But for the most part I am finding things I want to own and buying them at prices I'm comfortable paying. As a result, most accounts are close to fully invested.
No one knows how QE2 will play out, but it is slightly higher than what the market expected, and I would think that US dollar weakness will continue. PCM owns many names that have international operations, which is important for two reasons. First, other areas of the world are growing more rapidly than the US, and second, there will be a currency tailwind when international results are translated back into US dollars for reporting purposes.
A weaker US dollar is also one of the factors driving precious metals and other commodities, and I expect to hold our significant positions in gold and silver.
Oil and Energy
PCM portfolios own several energy names, and so I paid attention to the Saudi Arabian oil minister's recent comment that he was happy with oil prices between $70 and $90, raising the high end of the range from $80. Whether this is to compensate for a weakening dollar or some other reason I don't know.
My thinking with regards to oil and energy is threefold: 1) relying solely on US storage data as an investment guide is a mistake; 2) oil demand in developing nations is growing rapidly; 3) OPEC's spare capacity could dwindle more quickly than the market expects.
In addition to the Seadrill ("SDRL") I mentioned a couple months ago, I also own Schlumberger ("SLB"). Several executives recently exercised options and held the shares, which I take as a bullish indicator. Most recently I began buying Knightsbridge Tankers ("VLCCF") which has four double hull vessels to transport oil internationally. VLCCF sold off after announcing a secondary offering, and has subsequently rebounded strongly. VLCCF shares yield 9%, and I bought them for both income and custom accounts.
Can the equity markets be manipulated?
Why not? Historically the Federal Reserve has actively bought or sold fixed income securities in an effort to add or drain liquidity in the bond markets. This has been a very common tool for the Fed, which is usually used for technical reasons, that is, to maintain the appropriate liquidity in the system to hit their targeted Fed Funds rate. So why couldn't they buy equities or equity futures?
On balance, I would prefer to see equity markets that overcome early or mid day weakness and rally into the close, based on persistent demand. This has decidedly not been the case over the past few months, during which time about half the gains have come in overnight sessions which then led to days when the markets opened higher, never saw the red, and closed with solid gains. According to Jerry Hegarty (morning comments November 4), this is the antithesis of a true bull market, which would see about 45% of the market's gains takes place in the final hour. Regardless, it seems that we are headed for higher equity prices, at least through year end.
Miscellaneous
Last year Peattie Capital Management adopted the tag line "Invested in the Individual" to demonstrate the personal aspect of my approach and to emphasize that I manage separate accounts. I applied for the trademark rights to the phrase, and recently received them. Note the trademark protection in the purple bar above.
Please feel free to contact me with any questions or comments.
October 2010
+
October 7, 2010
Performance
Peattie Capital's range of returns in September for customized portfolios was 7.2% - 11.4%, and for the year the range is (1%) - 6.9%.
For income portfolios, the range in September was 6.3% - 8.7%, and for the year the range is 14.3% - 14.9%. As a reminder, the annual fee for income portfolios is 0.65% vs.1.25% for the first $1mm for a customized portfolio.
Returns for the S&P 500 are 8.8% and 2.3% respectively.
I mentioned last month that a long-term client has asked PCM to manage a dedicated short portfolio, as opposed to shorting in his existing income portfolio. This will be PCM's first dedicated short portfolio, and so PCM is now offering three strategies to its clients: a customized portfolio (which can be long and short), an income portfolio, and a dedicated short portfolio.
For a variety of reasons, we are holding off on activating the short portfolio, but I will report it's performance when we do so.
Biggest Position Has Great News
On September 30, KVH Industries ("KVHI") disclosed that the US Coast Guard had selected it to provide mobile communications services for its 216-member fleet, and the shares have subsequently jumped 20%. Last November the Coast Guard had selected KVHI for a subsector of its ships, and I have been optimistic that there would be a further roll out with the Coast Guard. This announcement validates the company's strategy and now that its global network is in place I would expect increasing adoption of its mini VSAT service, which provides satellite internet access to ships at sea.
KVHI is a significant holding in every portfolio, and is PCM's single largest holding. For more conservative accounts it is approximately a 5% position and for more aggressive ones it is as high as 14%. Generally, I limit exposure to any one name to ~15% of a portfolio, however from time to time there might be an exception to that. PCM portfolios rarely have more than 20 positions.
KVHI has been volatile, with both a 22% and 33% correction this year. I expect this kind of volatility to continue, and since it is such a material component of portfolios, it could lead to some individual portfolio volatility as well. However, I expect more good news from KVHI and have no intention of selling shares.
On occasion, there might be an opportunity to box KVHI, but doing so risks not being long when major announcements such as this one take place. So I will be very careful if I decide to do so.
Small Cap Opportunity
One reason Peattie Capital Management manages separate portfolios (rather than a fund) is to be able to buy small cap names like KVHI. Another good example of a small cap name we own is Digimarc ("DMRC") which we started buying almost two years ago when the market cap was $50mm. Today it is $175mm. (And, the shares are still a buy as far as I'm concerned).
Even a very small fund, say $50mm, would need to buy 45,000 shares of DMRC, roughly two days volume, to establish a 2% position. In contrast, separately managed accounts can easily buy/sell enough shares of names like KVHI and DMRC to "move the needle" and simultaneously not disrupt normal trading flows. PCM owns several other small cap names that are growing organic revenues quickly, are profitable, have little or no debt, and are still in the $100-$500 market cap range.
Staying With Precious Metals
While KVHI is the largest single position, in aggregate our gold and silver positions are bigger. We own the gold ETF ("GLD"), the silver ETF ("SLV"), Central Fund of Canada ("CEF") and also Sprott Resources ("SCP.TO").
I have discussed gold in many of my recent newsletters, and so I will refer anyone interested in my comments to the "News" section of PCM's website, www.peattiecapital.com where I post previous commentaries.
That said, there were three noteworthy events this month with regards to gold. First, Anglo Gold Ashanti, ("AU") Africa's largest gold producer, closed its hedges. Recall that Barrick Gold ("ABX") closed its hedges several months ago, and so two major producers have recently switched to an unhedged position.
Second, consultants GFMS, who compile statistics for gold, said that central banks would be net buyers of gold this year, after 10 consecutive years of being net sellers, with average sales of 442 tons of gold sold per year (Source: Financial Times, 9/15/10).
Third, CNN reported that gold ATM machines are coming to the US. There are 20 such machines already in place overseas, and the two in the US are expected to be operating in a month or so. One is expected in a major Las Vegas casino and the other in Florida.
Despite gold's run, it is still well below 1980's inflation adjusted all-time high of ~$2,200. Given the US's enormous deficit, (estimated at $50 trillion including unfunded liabilities) I think there will be ongoing pressure on the US dollar and hard assets will continue to benefit. I also have no intention of selling my gold and silver positions.
Domestic Banks Have Been Weak
One industry I have been early on is the major money center banks. The survivors have even greater market share than they had before the credit crisis, and are thus even more critical to the health of the financial system. If they were "too big to fail" before, and are now even bigger, how can they ever be allowed to fail in the future? Further, the positive and (thus far) steep yield curve is a boon to them, and accounting rules have been relaxed to allow for more flexibility in writing down assets.
Eventually, the remaining banks will work through the writedowns and there will be more clarity around recently passed financial regulation and reform. When the market perceives that that time is approaching, I think banks will trade at 10-12x (normalized) earnings whch will mean big moves for the likes of Bank of America ("BAC") Wells Fargo ("WFC") and JP Morgan ("JPM").
We also have a small position in Credicorp ("BAP") a Peruvian bank, which has performed much better than US banks. At 3x book value, it is expensive by normal measurements. However, I like the idea of having exposure to some of globe's faster growing areas, and credit penetration in Peru is only 25%, vs. 50% in Brazil.
Bullish Tidbit du Jour
I have referred to Don Hays as the most bullsh strategist I follow, and the title of his September 29th market comment is "When Do You Bet the House?" In it, he cites the combination of very low consumer sentiment with an extremely undervalued market (defined in relationship to bond yields) as being a "license to steal" which has produced "massive bull markets" in the past. His analysis concludes that we have those conditions right now, and that it is time to buy.
I have said repeatedly that I am interested in the right situations at the right price, but Hays also correctly called a turn a month ago and I have a great deal of respect for his approach. I hope he's right.
As always I welcome any comments or questions.
Performance
Peattie Capital's range of returns in September for customized portfolios was 7.2% - 11.4%, and for the year the range is (1%) - 6.9%.
For income portfolios, the range in September was 6.3% - 8.7%, and for the year the range is 14.3% - 14.9%. As a reminder, the annual fee for income portfolios is 0.65% vs.1.25% for the first $1mm for a customized portfolio.
Returns for the S&P 500 are 8.8% and 2.3% respectively.
I mentioned last month that a long-term client has asked PCM to manage a dedicated short portfolio, as opposed to shorting in his existing income portfolio. This will be PCM's first dedicated short portfolio, and so PCM is now offering three strategies to its clients: a customized portfolio (which can be long and short), an income portfolio, and a dedicated short portfolio.
For a variety of reasons, we are holding off on activating the short portfolio, but I will report it's performance when we do so.
Biggest Position Has Great News
On September 30, KVH Industries ("KVHI") disclosed that the US Coast Guard had selected it to provide mobile communications services for its 216-member fleet, and the shares have subsequently jumped 20%. Last November the Coast Guard had selected KVHI for a subsector of its ships, and I have been optimistic that there would be a further roll out with the Coast Guard. This announcement validates the company's strategy and now that its global network is in place I would expect increasing adoption of its mini VSAT service, which provides satellite internet access to ships at sea.
KVHI is a significant holding in every portfolio, and is PCM's single largest holding. For more conservative accounts it is approximately a 5% position and for more aggressive ones it is as high as 14%. Generally, I limit exposure to any one name to ~15% of a portfolio, however from time to time there might be an exception to that. PCM portfolios rarely have more than 20 positions.
KVHI has been volatile, with both a 22% and 33% correction this year. I expect this kind of volatility to continue, and since it is such a material component of portfolios, it could lead to some individual portfolio volatility as well. However, I expect more good news from KVHI and have no intention of selling shares.
On occasion, there might be an opportunity to box KVHI, but doing so risks not being long when major announcements such as this one take place. So I will be very careful if I decide to do so.
Small Cap Opportunity
One reason Peattie Capital Management manages separate portfolios (rather than a fund) is to be able to buy small cap names like KVHI. Another good example of a small cap name we own is Digimarc ("DMRC") which we started buying almost two years ago when the market cap was $50mm. Today it is $175mm. (And, the shares are still a buy as far as I'm concerned).
Even a very small fund, say $50mm, would need to buy 45,000 shares of DMRC, roughly two days volume, to establish a 2% position. In contrast, separately managed accounts can easily buy/sell enough shares of names like KVHI and DMRC to "move the needle" and simultaneously not disrupt normal trading flows. PCM owns several other small cap names that are growing organic revenues quickly, are profitable, have little or no debt, and are still in the $100-$500 market cap range.
Staying With Precious Metals
While KVHI is the largest single position, in aggregate our gold and silver positions are bigger. We own the gold ETF ("GLD"), the silver ETF ("SLV"), Central Fund of Canada ("CEF") and also Sprott Resources ("SCP.TO").
I have discussed gold in many of my recent newsletters, and so I will refer anyone interested in my comments to the "News" section of PCM's website, www.peattiecapital.com where I post previous commentaries.
That said, there were three noteworthy events this month with regards to gold. First, Anglo Gold Ashanti, ("AU") Africa's largest gold producer, closed its hedges. Recall that Barrick Gold ("ABX") closed its hedges several months ago, and so two major producers have recently switched to an unhedged position.
Second, consultants GFMS, who compile statistics for gold, said that central banks would be net buyers of gold this year, after 10 consecutive years of being net sellers, with average sales of 442 tons of gold sold per year (Source: Financial Times, 9/15/10).
Third, CNN reported that gold ATM machines are coming to the US. There are 20 such machines already in place overseas, and the two in the US are expected to be operating in a month or so. One is expected in a major Las Vegas casino and the other in Florida.
Despite gold's run, it is still well below 1980's inflation adjusted all-time high of ~$2,200. Given the US's enormous deficit, (estimated at $50 trillion including unfunded liabilities) I think there will be ongoing pressure on the US dollar and hard assets will continue to benefit. I also have no intention of selling my gold and silver positions.
Domestic Banks Have Been Weak
One industry I have been early on is the major money center banks. The survivors have even greater market share than they had before the credit crisis, and are thus even more critical to the health of the financial system. If they were "too big to fail" before, and are now even bigger, how can they ever be allowed to fail in the future? Further, the positive and (thus far) steep yield curve is a boon to them, and accounting rules have been relaxed to allow for more flexibility in writing down assets.
Eventually, the remaining banks will work through the writedowns and there will be more clarity around recently passed financial regulation and reform. When the market perceives that that time is approaching, I think banks will trade at 10-12x (normalized) earnings whch will mean big moves for the likes of Bank of America ("BAC") Wells Fargo ("WFC") and JP Morgan ("JPM").
We also have a small position in Credicorp ("BAP") a Peruvian bank, which has performed much better than US banks. At 3x book value, it is expensive by normal measurements. However, I like the idea of having exposure to some of globe's faster growing areas, and credit penetration in Peru is only 25%, vs. 50% in Brazil.
Bullish Tidbit du Jour
I have referred to Don Hays as the most bullsh strategist I follow, and the title of his September 29th market comment is "When Do You Bet the House?" In it, he cites the combination of very low consumer sentiment with an extremely undervalued market (defined in relationship to bond yields) as being a "license to steal" which has produced "massive bull markets" in the past. His analysis concludes that we have those conditions right now, and that it is time to buy.
I have said repeatedly that I am interested in the right situations at the right price, but Hays also correctly called a turn a month ago and I have a great deal of respect for his approach. I hope he's right.
As always I welcome any comments or questions.
September 2010
+
September 2, 2010
In August our range of returns was (5.8%) - (1.8%), and the S&P 500 returned (4.7%). For the year our range of returns is (9.6%) - +8.1% and the S&P 500 has returned (5.9%).
Core Holdings Were Weak in August
My biggest positions are mostly small and mid cap names, and several of them underperformed the market in August. This is frustrating as their fundamentals are excellent. With one possible exception, I have no intention of selling any of them. Our income positions were also weak. However, I continue to believe that Master Limited Partnerships are a good place to generate income and view their recent weakness as a buying opportunity.
Gold and silver were our best performers, each +4% for the month. I expect them to remain core holdings as well.
PCM Companies Reporting Strong Earnings
Harry Winston Diamonds ("HWD") was our final company to report second quarter earnings. Revenues grew 62% in the quarter and the company posted earnings per share of 22 cents vs. a loss of 33 cents last year. I am hoping to buy more HWD but will await a pullback as the shares are up 18% on the heels of the earnings report. HWD has significant international exposure, generating 85% of sales outside the US. I particularly like companies with profitable operations in some of the faster growing economies.
Heinz, ("HNZ") a name I own in several portfolios, preannounced quarterly earnings in excess of analyst estimates on August 31. HNZ gets 60% of it's revenues from overseas (roughly 20% from the emerging markets), yields 3.9%, and is reasonably valued at 14-15x forward earnings.
Overall, 75% of the S&P 500 had better-than-expected results on both the top and bottom lines, according to Bob Doll, Vice Chairman and Chief Equity Strategist at BlackRock.
New Customized Account
Peattie Capital has just opened a dedicated short account for a long-time client, someone with nearly 40 years of investing experience. This account is meant to hedge his significant equity holdings and will hold only short positions (and possibly paired trades). I don't recommend this route for everyone, but it is an example of how Peattie Capital creates customized solutions based on a client's specific needs. I have found a number of names for this portfolio and may short a few of them in other portfolios as well.
Conflicting Data....What Else Is New?
There are any number of troubling issues such as employment trends, the sharp drop in housing activity, the "unusually uncertain" economy, and the enormous debt burden, to name a few. In addition, technicians are pointing out that charts of several major indices appear to be rolling over, and in August there was only one instance of consecutive S&P futures closing higher (August 16 +1 point and August 17 +12 points). In addition to these poor technicals, September and October tend to be weak, and sometimes quite volatile.
On the other hand, the most recent American Association of Individual Investors (AAII) Survey (August 26), showed a drop in the number of "bullish" respondents to the 20% range, a level that has been reached 48 other times since 1987. In the subsequent three months, the market was up 98% of the time, by an average of 5.8% (Don Hays "Rainbows and Unicorns" August 26, 2010). The last time the AAII Survey hit 20% was March, 2009, right when the market took off.
Hays also cites the Presidential Cycle, which tracks market performance during different periods of a Presidency. The most bullish six-month period is the one that begins November of the mid-term election year. Since 1930, the median return for this six-month span is 16%,(ibid)and there hasn't been a down period since 1948. The return from the mid-cycle election year low to the following year's high has averaged almost 50% since 1914.
As far as I'm concerned there is always conflicting economic data, and so Peattie Capital's approach is to find individual situations and be involved in them at the right price. Then I will use shorts, boxes, and cash to hedge overall market exposure. I remain excited about our positions and look forward to seeing their strong fundamentals drive higher share prices soon.
Low Rates Continue
Anyone with a long-term horizon should be careful buying bonds at today's historically low rates and consider instead a basket of seasoned, large cap global names with solid operating metrics, strong cash flows and dividends in excess of 3%. There are any number of such companies and several Peattie Capital portfolios hold some of them.
I don't believe bonds are in a bubble; how could they be when lenders will get their principal back? However, 2.60% per year for 10 years (the yield of the current 10-year Treasury Note) isn't appealing, and there will be some significant price volatility if rates back up. I have had several conversations with people who don't understand that their bonds' values can decline, and so it's worth reiterating that they can.
In August our range of returns was (5.8%) - (1.8%), and the S&P 500 returned (4.7%). For the year our range of returns is (9.6%) - +8.1% and the S&P 500 has returned (5.9%).
Core Holdings Were Weak in August
My biggest positions are mostly small and mid cap names, and several of them underperformed the market in August. This is frustrating as their fundamentals are excellent. With one possible exception, I have no intention of selling any of them. Our income positions were also weak. However, I continue to believe that Master Limited Partnerships are a good place to generate income and view their recent weakness as a buying opportunity.
Gold and silver were our best performers, each +4% for the month. I expect them to remain core holdings as well.
PCM Companies Reporting Strong Earnings
Harry Winston Diamonds ("HWD") was our final company to report second quarter earnings. Revenues grew 62% in the quarter and the company posted earnings per share of 22 cents vs. a loss of 33 cents last year. I am hoping to buy more HWD but will await a pullback as the shares are up 18% on the heels of the earnings report. HWD has significant international exposure, generating 85% of sales outside the US. I particularly like companies with profitable operations in some of the faster growing economies.
Heinz, ("HNZ") a name I own in several portfolios, preannounced quarterly earnings in excess of analyst estimates on August 31. HNZ gets 60% of it's revenues from overseas (roughly 20% from the emerging markets), yields 3.9%, and is reasonably valued at 14-15x forward earnings.
Overall, 75% of the S&P 500 had better-than-expected results on both the top and bottom lines, according to Bob Doll, Vice Chairman and Chief Equity Strategist at BlackRock.
New Customized Account
Peattie Capital has just opened a dedicated short account for a long-time client, someone with nearly 40 years of investing experience. This account is meant to hedge his significant equity holdings and will hold only short positions (and possibly paired trades). I don't recommend this route for everyone, but it is an example of how Peattie Capital creates customized solutions based on a client's specific needs. I have found a number of names for this portfolio and may short a few of them in other portfolios as well.
Conflicting Data....What Else Is New?
There are any number of troubling issues such as employment trends, the sharp drop in housing activity, the "unusually uncertain" economy, and the enormous debt burden, to name a few. In addition, technicians are pointing out that charts of several major indices appear to be rolling over, and in August there was only one instance of consecutive S&P futures closing higher (August 16 +1 point and August 17 +12 points). In addition to these poor technicals, September and October tend to be weak, and sometimes quite volatile.
On the other hand, the most recent American Association of Individual Investors (AAII) Survey (August 26), showed a drop in the number of "bullish" respondents to the 20% range, a level that has been reached 48 other times since 1987. In the subsequent three months, the market was up 98% of the time, by an average of 5.8% (Don Hays "Rainbows and Unicorns" August 26, 2010). The last time the AAII Survey hit 20% was March, 2009, right when the market took off.
Hays also cites the Presidential Cycle, which tracks market performance during different periods of a Presidency. The most bullish six-month period is the one that begins November of the mid-term election year. Since 1930, the median return for this six-month span is 16%,(ibid)and there hasn't been a down period since 1948. The return from the mid-cycle election year low to the following year's high has averaged almost 50% since 1914.
As far as I'm concerned there is always conflicting economic data, and so Peattie Capital's approach is to find individual situations and be involved in them at the right price. Then I will use shorts, boxes, and cash to hedge overall market exposure. I remain excited about our positions and look forward to seeing their strong fundamentals drive higher share prices soon.
Low Rates Continue
Anyone with a long-term horizon should be careful buying bonds at today's historically low rates and consider instead a basket of seasoned, large cap global names with solid operating metrics, strong cash flows and dividends in excess of 3%. There are any number of such companies and several Peattie Capital portfolios hold some of them.
I don't believe bonds are in a bubble; how could they be when lenders will get their principal back? However, 2.60% per year for 10 years (the yield of the current 10-year Treasury Note) isn't appealing, and there will be some significant price volatility if rates back up. I have had several conversations with people who don't understand that their bonds' values can decline, and so it's worth reiterating that they can.
August 2010
+
August 4, 2010
In July, our range of returns was +2.9%-+5.8%, and the S&P 500 returned +6.9%. For the year, our range of returns is -4.6%-+10.7% and the S&P 500 has returned -1.2%.
Corellations Rising
In just the past two weeks, I have seen several articles discussing Peattie Capital's primary investment message: that is, that correlations between stocks and asset classes are much higher than previously thought. Therefore, the widely-touted asset allocation programs sold by the major investment firms, based on the idea that asset classes are predictably uncorrelated, have proven to be unsuccessful at hedging or diversifying away market risk. As I've said before, if you think your assets are protected from a major market downturn because you have such a program, you are mistaken. Your portfolio will behave much like the market does if we see another leg down.
Three such articles are: "Did Investors Learn Anything From 2008's Crash?" (Barron's July 26, 2010, by Jack Willoughby); "Investors Forced To Live In A World of Correlation" (FT July 24, 2010 by John Authers); and "Stock Picks Tough as Asset Paths Correlate" (FT July 20, 2010 by Anousha Sakoui and Izabella Kaminska). I plan to add these articles to my website, www.peattiecapital.com.
In contrast, Peattie Capital believes in "the land of tall trees." We invest in companies we believe in and create individual portolios based on individual circumstances. We hedge market risk by using puts and calls, by shorting and boxing, by raising cash, and by judiciously using inversely correlated ETFs.
Great Fundamentals
KVH Industries ("KVHI") delivered it's second consecutive record for quarterly revenue, and for the first six month of the year has grown revenues 43%. For the first half of 2010, KVHI reported earnings per share of 23 cents, against a loss of 17 cents in the first half of 2009. KVHI is a good example of a company that is delivering terrific fundamentals, and yet the share price has dropped 7% for the year (although the shares gained ~150% in 2009). With virtually no debt and $3 per share in cash on the balance sheet, we believe KVHI is conservatively capitalized and positioned for further growth. We will continue to own KVH in every account.
Another name that continues to execute beautifully is Digimarc ("DMRC"). This micro cap ($140mm) name grew revenues 76% in the first half of 2010 vs. last year's first half. It also delivered 39 cents of earnings, vs. a loss of 21 cents in the first half of 2009. DMRC has no debt and $6.50 per share in cash on the balance sheet. Like KVHI, DMRC generates a significant and growing portion of it's revenues from recurring sources, such as services, subscriptions and licensing. DMRC shares gained +10% in July and are up 35% for the year. It is up roughly 130% since we began buying it 20 months ago.
New Positions
I have begun buying shares of Fuel-Tech ("FTEK")which I've owned on and off for several years. FTEK has some terrific technology to help reduce emissions at utilities and other power generators. The shares have performed poorly the past few years, dropping from the low $30's to ~$6 a couple months ago. However, I believe the products are good ones and that the company will work. Employees must too as they have been buying shares in droves recently.
I have also been adding shares of the Norwegian deep water driller Seadrill ("SDRL") which started trading in the US in April. The shares have corrected from ~$28 to $18 in sympathy with other deep-water drillers after the gulf oil disaster. Unlike its peers, however, SDRL has a relatively new fleet, and had only one rig operating in the Gulf of Mexico. In 2009, SDRL earned $3.00 per share and paid $2.00 in dividends.
Income Accounts Strong
The best performer among my accounts is an income account, which consists primarily of energy related Master Limited Partnerships. My belief is that, for several reasons, this trade is on track. In addition to the significantly higher yields relative to other asset classes, (ranging from 6-9% while US Treasury yields continue to drop), MLPs come with attractive tax advantages on those distributions. While there is a great deal of conversation about renewing the soon-to-expire Bush tax cuts, so far there has been no discussion of changing the tax treatment of MLP distributions. Also, the price of oil has been rising, and, while most my MLPs don't require a higher oil price to grow earnings, prices tend to track the price of oil.
As I've said many times, I am long-term bullish on oil prices, on the belief that supply is constrained and demand, especially from emerging economies, will continue to grow. The International Energy Agency recently announced that China has overtaken the US to become the world's largest energy consumer. Chinese oil demand currently stands at approximately 2 barrels per capita per year, compared to 20 barrels in the US, 14 in Japan, and 11-13 in Western Europe. (Source: Elliott Gue, The Energy Letter, August 2, 2010)
With a population of 1.3 billion, it won't take much of an increase in Chinese per capita consumption to accelerate aggregate petroleum demand. China also recently overtook the US to become the world's largest automobile market. It's no wonder the Chinese are securing resources all over the globe, buying coal reserves in Australia, entering supply agreements for natural gas with Russia, and investing in oil projects in Africa, South America, and the Middle East. (Source: ibid)
Summary
Uncertainty, conflicting economic data and highly correlated assets continue. That said, several of our core holdings are delivering organic revenue and earnings growth and I am looking forward to seeing corresponding share price increases in the future.
In July, our range of returns was +2.9%-+5.8%, and the S&P 500 returned +6.9%. For the year, our range of returns is -4.6%-+10.7% and the S&P 500 has returned -1.2%.
Corellations Rising
In just the past two weeks, I have seen several articles discussing Peattie Capital's primary investment message: that is, that correlations between stocks and asset classes are much higher than previously thought. Therefore, the widely-touted asset allocation programs sold by the major investment firms, based on the idea that asset classes are predictably uncorrelated, have proven to be unsuccessful at hedging or diversifying away market risk. As I've said before, if you think your assets are protected from a major market downturn because you have such a program, you are mistaken. Your portfolio will behave much like the market does if we see another leg down.
Three such articles are: "Did Investors Learn Anything From 2008's Crash?" (Barron's July 26, 2010, by Jack Willoughby); "Investors Forced To Live In A World of Correlation" (FT July 24, 2010 by John Authers); and "Stock Picks Tough as Asset Paths Correlate" (FT July 20, 2010 by Anousha Sakoui and Izabella Kaminska). I plan to add these articles to my website, www.peattiecapital.com.
In contrast, Peattie Capital believes in "the land of tall trees." We invest in companies we believe in and create individual portolios based on individual circumstances. We hedge market risk by using puts and calls, by shorting and boxing, by raising cash, and by judiciously using inversely correlated ETFs.
Great Fundamentals
KVH Industries ("KVHI") delivered it's second consecutive record for quarterly revenue, and for the first six month of the year has grown revenues 43%. For the first half of 2010, KVHI reported earnings per share of 23 cents, against a loss of 17 cents in the first half of 2009. KVHI is a good example of a company that is delivering terrific fundamentals, and yet the share price has dropped 7% for the year (although the shares gained ~150% in 2009). With virtually no debt and $3 per share in cash on the balance sheet, we believe KVHI is conservatively capitalized and positioned for further growth. We will continue to own KVH in every account.
Another name that continues to execute beautifully is Digimarc ("DMRC"). This micro cap ($140mm) name grew revenues 76% in the first half of 2010 vs. last year's first half. It also delivered 39 cents of earnings, vs. a loss of 21 cents in the first half of 2009. DMRC has no debt and $6.50 per share in cash on the balance sheet. Like KVHI, DMRC generates a significant and growing portion of it's revenues from recurring sources, such as services, subscriptions and licensing. DMRC shares gained +10% in July and are up 35% for the year. It is up roughly 130% since we began buying it 20 months ago.
New Positions
I have begun buying shares of Fuel-Tech ("FTEK")which I've owned on and off for several years. FTEK has some terrific technology to help reduce emissions at utilities and other power generators. The shares have performed poorly the past few years, dropping from the low $30's to ~$6 a couple months ago. However, I believe the products are good ones and that the company will work. Employees must too as they have been buying shares in droves recently.
I have also been adding shares of the Norwegian deep water driller Seadrill ("SDRL") which started trading in the US in April. The shares have corrected from ~$28 to $18 in sympathy with other deep-water drillers after the gulf oil disaster. Unlike its peers, however, SDRL has a relatively new fleet, and had only one rig operating in the Gulf of Mexico. In 2009, SDRL earned $3.00 per share and paid $2.00 in dividends.
Income Accounts Strong
The best performer among my accounts is an income account, which consists primarily of energy related Master Limited Partnerships. My belief is that, for several reasons, this trade is on track. In addition to the significantly higher yields relative to other asset classes, (ranging from 6-9% while US Treasury yields continue to drop), MLPs come with attractive tax advantages on those distributions. While there is a great deal of conversation about renewing the soon-to-expire Bush tax cuts, so far there has been no discussion of changing the tax treatment of MLP distributions. Also, the price of oil has been rising, and, while most my MLPs don't require a higher oil price to grow earnings, prices tend to track the price of oil.
As I've said many times, I am long-term bullish on oil prices, on the belief that supply is constrained and demand, especially from emerging economies, will continue to grow. The International Energy Agency recently announced that China has overtaken the US to become the world's largest energy consumer. Chinese oil demand currently stands at approximately 2 barrels per capita per year, compared to 20 barrels in the US, 14 in Japan, and 11-13 in Western Europe. (Source: Elliott Gue, The Energy Letter, August 2, 2010)
With a population of 1.3 billion, it won't take much of an increase in Chinese per capita consumption to accelerate aggregate petroleum demand. China also recently overtook the US to become the world's largest automobile market. It's no wonder the Chinese are securing resources all over the globe, buying coal reserves in Australia, entering supply agreements for natural gas with Russia, and investing in oil projects in Africa, South America, and the Middle East. (Source: ibid)
Summary
Uncertainty, conflicting economic data and highly correlated assets continue. That said, several of our core holdings are delivering organic revenue and earnings growth and I am looking forward to seeing corresponding share price increases in the future.
July 2010
+
July 2, 2010
In June the range of our returns was -6.2% - +2.1%. For the year the range is -8.4% - +4.6%. The S&P 500 returned -5.4% for the month and has returned -7.6% for the year.
Lowest Yields Ever To me the most noteworthy event in June was the performance of the bond market, which is signalling an uncertain economy still mired in a debt-deflationary cycle. The coupon on the new two-year note is 0.625%, the lowest ever, and the yield dipped below .6 on June 29th. The only other time in history the yield has been this low was when Lehman collapsed, amidst fears that the entire financial system was on the verge of a meltdown.
If deflation is in our future, I would expect significant pressure on most asset classes, including equities, commodities, and real estate. Bonds can continue to appreciate, but with rates this low, there will be some limits as to how well they can perform.
One of my bigger concerns is that the Fed is out of ammunition. There is no more room to cut interest rates, and there is an increasing groundswell against issuing more Treasury debt and resuming quantitative easing. Joblessness persists, and leading indicators have been rolling over. I think the chances of the Fed raising short-term rates in the near future are virtually nil.
On the plus side, the yield curve is still positive, corporate balance sheets are in good shape, and valuations, particularly compared to fixed income alternatives, are reasonable. If S&P earnings come through as expected (granted, a big if) the market is trading at roughly 13x 2010's estimates. Given the low term structure of rates that's attractive, and even in a more normalized interest rate environment it's below long-term averages.
Nonetheless I am maintaining a cautious approach. At the close on June 30, the S&P broke below a quadruple bottom of 1040, which it hit on Feb. 5, and then successfully held on May 25, June 8 and June 29. I am not a technician, but this kind of action is noteworthy. I'm not sure what the catalyst is to get things going again: June's brief mid-month rally came after a five-day period of exceptionally high fear (the average put/call ratio for the June 8-June 14 period was 1.06; normally it is .9), and good earnings are already anticipated.
It may be helpful if the financial reform legislation is signed into law soon. Doing so would remove one of the many uncertainties (such as potential tax hikes and the effects of health care reform, among others) facing the market today
Peattie Capital Website Increasingly I hear from prospective clients that they have an asset allocation program, which they feel is the best way to manage their wealth. I respectfully disagree, and hereby warn anyone reading this that if you have such a program and think your assets will survive more or less intact if the markets have another leg down you are mistaken. These programs are mostly beneficial to whoever is selling them, because they generate a steady stream of fees. They sound plausible, and can be useful for institutions who have a longer time frame or who define risk as underperforming an index. However, for individuals they are ineffective and inappropriate.
Recently I launched www.peattiecapital.com (click here). One theme of the site is to educate investors to the limits of these asset allocation programs. Starting with a bond/equity split is fine, but carving out percentage allocations within equities is ineffective at protecting wealth, because in a down market all the correlations go to one. In addition, there is no ability to take advantage of imbalances and short-term opportunities should they arise.
Given the trends I see now, such as dark pools and high speed electronic trading, it seems to me that, if anything, correlations will increase even more. As much as 70% of the share trading volume on the US exchanges is now high frequency trading, according to Michael Gordon in the June 8 FT.
Alternatively, Peattie Capital works very hard to find specific situations that represent opportunity. Then we will short, box, hedge, and raise cash to protect overall portfolio value. We believe in concentrated portfolios, and we think flexibility is an asset. We believe our emphasis on risk management will lead to much better performance than any asset allocation program, particularly in a down market. We have no lockups or profit sharing plans, and we are committed to always acting in the best interest of the client.
Another Customized Solution Despite my near-term caution, I have begun discussing another customized solution for certain clients, much like I developed and marketed the "Income Account" last year. This idea applies to anyone with a 10-year time horizon, who otherwise might invest in the 10-year Treasury Note (current yield: 2.94%). If you buy the 10-year today and hold it to maturity you will get your principal back, along with your miniscule return, even more miniscule after taxes. But if you need to sell before maturity there's no telling what price you'll receive, especially if inflation kicks in and rates are backing up.
Alternatively, buying a well chosen basket of corporate equities has a good chance to provide a greater return than the 10-year will. (Note: Warren Buffet has discussed this idea in the past, and more recently Grant's Interest Rate Observer suggested it as well). The key is to buy the right equities. Each selection must have at least a $5bn market cap, pay a 2%+ dividend, have attractive operating metrics and trade today at what historically has been a good valuation (low teens P/E).
If you review the US equity market since it peaked in 1929, you will see a continuous cycle of alternating 18-20 year periods of bearish then bullish performance. After the market peaked in October, 1929, a bear market began, which lasted 17 years. Then, in 1946 a bull market began, which lasted 20 years. In 1966 another bear started with the Dow at 1000 and in 1982 it ended with the Dow at 800. Think about that...16 years and a -20% return! From 1982 until 2000 we had a significant bull market, which peaked in March, 2000 with the S&P 500 at 1527. (Note: I view the October, 2007 S&P close as a confirmation of the March, 2000 peak, even though it was slightly higher.)
In the decade ending 12/31/09, the S&P fell 24.1% excluding dividends, not as bad as the 1930s, when it fell 41.9%. Including dividends, and on an annualized basis, it was worse as it returned -0.95% annually vs. +1.0% in the 1930s (source: Jim Grant, 6/11/10). My point is, great bear markets take their time. While I don't anticipate another 10-year period like we've just had, things could remain bumpy for a while. That is why I advocate a 10-year period for this idea.
Current Holdings Our gold and silver positions performed well in June, and so did the MLPs in our income accounts. I expect to continue to hold these and will likely do dome hedging for the income accounts, probably by shorting oil. I have also been sprinkling in a few other hedges and raising more cash. As I've said many times, I own gold not as an inflation hedge but rather as protection against all fiat currency.
I am hoping that we will soon move away from this binary "risk on/risk off" market, and that stockpicking will be rewarded. So far, however, this is not happening.
Earnings season is about to begin and I am particularly concerned about companies that sell directly to the consumer. Best Buy, Research in Motion, Bed, Bath and Beyond, and Nike all underperformed the market immediately after reporting. Consumer deleveraging continues and the market is not tolerating any disppointments.
In June the range of our returns was -6.2% - +2.1%. For the year the range is -8.4% - +4.6%. The S&P 500 returned -5.4% for the month and has returned -7.6% for the year.
Lowest Yields Ever To me the most noteworthy event in June was the performance of the bond market, which is signalling an uncertain economy still mired in a debt-deflationary cycle. The coupon on the new two-year note is 0.625%, the lowest ever, and the yield dipped below .6 on June 29th. The only other time in history the yield has been this low was when Lehman collapsed, amidst fears that the entire financial system was on the verge of a meltdown.
If deflation is in our future, I would expect significant pressure on most asset classes, including equities, commodities, and real estate. Bonds can continue to appreciate, but with rates this low, there will be some limits as to how well they can perform.
One of my bigger concerns is that the Fed is out of ammunition. There is no more room to cut interest rates, and there is an increasing groundswell against issuing more Treasury debt and resuming quantitative easing. Joblessness persists, and leading indicators have been rolling over. I think the chances of the Fed raising short-term rates in the near future are virtually nil.
On the plus side, the yield curve is still positive, corporate balance sheets are in good shape, and valuations, particularly compared to fixed income alternatives, are reasonable. If S&P earnings come through as expected (granted, a big if) the market is trading at roughly 13x 2010's estimates. Given the low term structure of rates that's attractive, and even in a more normalized interest rate environment it's below long-term averages.
Nonetheless I am maintaining a cautious approach. At the close on June 30, the S&P broke below a quadruple bottom of 1040, which it hit on Feb. 5, and then successfully held on May 25, June 8 and June 29. I am not a technician, but this kind of action is noteworthy. I'm not sure what the catalyst is to get things going again: June's brief mid-month rally came after a five-day period of exceptionally high fear (the average put/call ratio for the June 8-June 14 period was 1.06; normally it is .9), and good earnings are already anticipated.
It may be helpful if the financial reform legislation is signed into law soon. Doing so would remove one of the many uncertainties (such as potential tax hikes and the effects of health care reform, among others) facing the market today
Peattie Capital Website Increasingly I hear from prospective clients that they have an asset allocation program, which they feel is the best way to manage their wealth. I respectfully disagree, and hereby warn anyone reading this that if you have such a program and think your assets will survive more or less intact if the markets have another leg down you are mistaken. These programs are mostly beneficial to whoever is selling them, because they generate a steady stream of fees. They sound plausible, and can be useful for institutions who have a longer time frame or who define risk as underperforming an index. However, for individuals they are ineffective and inappropriate.
Recently I launched www.peattiecapital.com (click here). One theme of the site is to educate investors to the limits of these asset allocation programs. Starting with a bond/equity split is fine, but carving out percentage allocations within equities is ineffective at protecting wealth, because in a down market all the correlations go to one. In addition, there is no ability to take advantage of imbalances and short-term opportunities should they arise.
Given the trends I see now, such as dark pools and high speed electronic trading, it seems to me that, if anything, correlations will increase even more. As much as 70% of the share trading volume on the US exchanges is now high frequency trading, according to Michael Gordon in the June 8 FT.
Alternatively, Peattie Capital works very hard to find specific situations that represent opportunity. Then we will short, box, hedge, and raise cash to protect overall portfolio value. We believe in concentrated portfolios, and we think flexibility is an asset. We believe our emphasis on risk management will lead to much better performance than any asset allocation program, particularly in a down market. We have no lockups or profit sharing plans, and we are committed to always acting in the best interest of the client.
Another Customized Solution Despite my near-term caution, I have begun discussing another customized solution for certain clients, much like I developed and marketed the "Income Account" last year. This idea applies to anyone with a 10-year time horizon, who otherwise might invest in the 10-year Treasury Note (current yield: 2.94%). If you buy the 10-year today and hold it to maturity you will get your principal back, along with your miniscule return, even more miniscule after taxes. But if you need to sell before maturity there's no telling what price you'll receive, especially if inflation kicks in and rates are backing up.
Alternatively, buying a well chosen basket of corporate equities has a good chance to provide a greater return than the 10-year will. (Note: Warren Buffet has discussed this idea in the past, and more recently Grant's Interest Rate Observer suggested it as well). The key is to buy the right equities. Each selection must have at least a $5bn market cap, pay a 2%+ dividend, have attractive operating metrics and trade today at what historically has been a good valuation (low teens P/E).
If you review the US equity market since it peaked in 1929, you will see a continuous cycle of alternating 18-20 year periods of bearish then bullish performance. After the market peaked in October, 1929, a bear market began, which lasted 17 years. Then, in 1946 a bull market began, which lasted 20 years. In 1966 another bear started with the Dow at 1000 and in 1982 it ended with the Dow at 800. Think about that...16 years and a -20% return! From 1982 until 2000 we had a significant bull market, which peaked in March, 2000 with the S&P 500 at 1527. (Note: I view the October, 2007 S&P close as a confirmation of the March, 2000 peak, even though it was slightly higher.)
In the decade ending 12/31/09, the S&P fell 24.1% excluding dividends, not as bad as the 1930s, when it fell 41.9%. Including dividends, and on an annualized basis, it was worse as it returned -0.95% annually vs. +1.0% in the 1930s (source: Jim Grant, 6/11/10). My point is, great bear markets take their time. While I don't anticipate another 10-year period like we've just had, things could remain bumpy for a while. That is why I advocate a 10-year period for this idea.
Current Holdings Our gold and silver positions performed well in June, and so did the MLPs in our income accounts. I expect to continue to hold these and will likely do dome hedging for the income accounts, probably by shorting oil. I have also been sprinkling in a few other hedges and raising more cash. As I've said many times, I own gold not as an inflation hedge but rather as protection against all fiat currency.
I am hoping that we will soon move away from this binary "risk on/risk off" market, and that stockpicking will be rewarded. So far, however, this is not happening.
Earnings season is about to begin and I am particularly concerned about companies that sell directly to the consumer. Best Buy, Research in Motion, Bed, Bath and Beyond, and Nike all underperformed the market immediately after reporting. Consumer deleveraging continues and the market is not tolerating any disppointments.
June 2010
+
June 2, 2010
In May, the range of our returns was 0%-(14.7%), and for the year the range is 3.0%-(12.8%). Returns for the S&P 500 were (8.2%) and (2.3%) respectively. As a group, PCM accounts were (6.1%) in May and are (.7%) for the year to date.
For both the month and year, the large negative performer is one of my personal accounts, where I own only one name.
VOLATILITY RETURNS What a month. 16 of the last 24 sessions saw 200+ point swings in the Dow, and from peak to trough the correction is roughly 15% (intraday) through May 28. The May 6 "flash crash" is a reminder that markets are still fragile and much more interconnected than most people realize. I don't believe there was "trader error" or a technical malfunction; I think what started as a bit of selling in an overbought market triggered more selling and bids disappeared very quickly.
May's trading demonstrates once again that in a down market allegedly uncorrellated assets and asset classes are actually highly correllated. As John Authers said in a recent FT article ("Market Forces" 5/22-23/10) "risk management becomes impossible when all markets move in unison."
So, if you have a standard "asset allocation" program, widely touted and marketed by the major investment firms as the best way to manage wealth, and you think you are reasonably protected from a serious bear market, think again. If the market goes down 30%, 40% or whatever, your account will too.
Asset allocation is very popular with asset managers and investment banks as it is a highly profitable and consistent fee-generating revenue source. For investment banks in particular, this is very helpful as their other businesses tend to be unpredictable.
In contrast, Peattie Capital uses a more flexible approach. First we search out the right situations and get involved at the right price. Then we will short, box, and otherwise hedge to protect overall portfolio value. Depending on our view of the market and any given client's goals, we will hold cash and wait for the right opportunity.
CURRENT ENVIRONMENT In the near term, my guess is the volatility continues, and I expect to maintain, or possibly add to, our hedges. In May, the market did not have any consecutive up sessions and so momentum trading (i.e. buying a rising market) was punished. The time to add to positions, which I am doing selectively, is on down days, not up ones.
My intermediate term view is cautious as well, but with a dash of optimism. The caution stems from the european debt crisis, and whether it is contained. In addition, there are questions about financial reform, a possible slowdown in China, and lingering questions about home prices and employment gains. And structurally, our debt addiction remains a problem.
My biggest fear is that the Fed has little ammunition left to stimulate the economy if it tails off again. Who would've thought that we could have a 0% Fed Funds rate for 18 months and still be worried about deflation and generating a self-sustaining economic cycle?
On the plus side, we now have a confluence of fear, sentiment, and valuation gauges that has represented a good time to buy in the past. Specifically, according to Don Hays (June 1, 2010): the three-week rolling put/call ratio has moved from 78% to 110% (normally .9), and there is increasing insider buying. The S&P is 13.6x 2010's $80 earnings estimate, compared to a (roughly) 15x long-term average. Also, there is significant liquidity in the system and yields on most other instruments are pretty meager. Even with May's flight to quality in Treasuries, the yield curve remains steep, and I don't expect to see an increase in short-term rates for at least six to nine months.
The most interesting analogy I have seen regarding today's markets is in this weeekend's Barron's, where Michael Santoli, quoting Ned Davis Research, discusses the parallels between 2010 and 1962. Back then the Dow peaked on April 23, and sold off 17% by the end of May. The final bottom came in late June and was down 23% from the April high. 1962 was also the second year of a young Democratic president's term and had a backdrop of low interest rates and a "sturdy" economy.
STAYING WITH MLPs Broadly speaking I still like energy-related Master Limited Partnerships despite their in-line performance in May. I am focused on companies that are growing their distributable cash flow, can easily cover that distribution, who have little/no debt maturing in the next couple years, and who are hedged.
MLPs bounced back from the 2008 disaster and in many cases went on to set new highs. One subset that I track was down 41% in 2008, but then added 119% in 2009. And, owners continued to receive tax-advantaged dividends, with yields ranging from roughly 7-11% throughout the cycle.
MLPs appear to be trading with the price of oil, but the fundamentals are strong and I would expect to hold MLPs if we get a major selloff. I was able to (mostly) successfully hedge my single biggest income portfolio in May, a highly focused portfolio with only 10 positions, by shorting oil and the S&P 500 in the account. I will be looking to add to my oil short, as a hedge for the MLPs, in several other accounts that own them.
BAD BEHAVIOR: COINCIDENCE OR A PATTERN? In just the last couple weeks we've had stories that Goldman Sachs is negotiating with the SEC to plea to a lesser charge and thus avoid formal fraud charges in the ongoing investigation of its Abacus transaction. In addition, Reuters is reporting that Goldman told the California Pension Fund that it was not a target of any formal investigation, when, in fact, it had recently received a Wells Notice.
Also, Thomas Weisel Partners has been accused of selling $25mm of Auction Rate Preferred Stock out of their own book and into the accounts of three corporate customers, for the purpose of raising cash to pay employee bonuses. The allegation is that, since the public market for these securities was frozen, Weisel "stuffed" the securities where they could and let the customer deal with the illiquidity problem. (Note: Weisel has denied the charges)
Lastly, a few days ago Art Samberg, a veteran hedge fund manager, settled charges with the SEC that he had profited by $14.8 million by trading on insider information several years ago. He agreed to a $28 million fine and has also agreed to be barred from working as an investment advisor.
At one point these incidents would've been considered isolated and random. But more and more, behavior in the finacial markets reminds me of athletes taking performance enhancing drugs: everyone else is doing it and the ends justify the means. Shameful.
Please feel free to contact me with any questions or comments and let me know if you'd like to be removed from distribution.
In May, the range of our returns was 0%-(14.7%), and for the year the range is 3.0%-(12.8%). Returns for the S&P 500 were (8.2%) and (2.3%) respectively. As a group, PCM accounts were (6.1%) in May and are (.7%) for the year to date.
For both the month and year, the large negative performer is one of my personal accounts, where I own only one name.
VOLATILITY RETURNS What a month. 16 of the last 24 sessions saw 200+ point swings in the Dow, and from peak to trough the correction is roughly 15% (intraday) through May 28. The May 6 "flash crash" is a reminder that markets are still fragile and much more interconnected than most people realize. I don't believe there was "trader error" or a technical malfunction; I think what started as a bit of selling in an overbought market triggered more selling and bids disappeared very quickly.
May's trading demonstrates once again that in a down market allegedly uncorrellated assets and asset classes are actually highly correllated. As John Authers said in a recent FT article ("Market Forces" 5/22-23/10) "risk management becomes impossible when all markets move in unison."
So, if you have a standard "asset allocation" program, widely touted and marketed by the major investment firms as the best way to manage wealth, and you think you are reasonably protected from a serious bear market, think again. If the market goes down 30%, 40% or whatever, your account will too.
Asset allocation is very popular with asset managers and investment banks as it is a highly profitable and consistent fee-generating revenue source. For investment banks in particular, this is very helpful as their other businesses tend to be unpredictable.
In contrast, Peattie Capital uses a more flexible approach. First we search out the right situations and get involved at the right price. Then we will short, box, and otherwise hedge to protect overall portfolio value. Depending on our view of the market and any given client's goals, we will hold cash and wait for the right opportunity.
CURRENT ENVIRONMENT In the near term, my guess is the volatility continues, and I expect to maintain, or possibly add to, our hedges. In May, the market did not have any consecutive up sessions and so momentum trading (i.e. buying a rising market) was punished. The time to add to positions, which I am doing selectively, is on down days, not up ones.
My intermediate term view is cautious as well, but with a dash of optimism. The caution stems from the european debt crisis, and whether it is contained. In addition, there are questions about financial reform, a possible slowdown in China, and lingering questions about home prices and employment gains. And structurally, our debt addiction remains a problem.
My biggest fear is that the Fed has little ammunition left to stimulate the economy if it tails off again. Who would've thought that we could have a 0% Fed Funds rate for 18 months and still be worried about deflation and generating a self-sustaining economic cycle?
On the plus side, we now have a confluence of fear, sentiment, and valuation gauges that has represented a good time to buy in the past. Specifically, according to Don Hays (June 1, 2010): the three-week rolling put/call ratio has moved from 78% to 110% (normally .9), and there is increasing insider buying. The S&P is 13.6x 2010's $80 earnings estimate, compared to a (roughly) 15x long-term average. Also, there is significant liquidity in the system and yields on most other instruments are pretty meager. Even with May's flight to quality in Treasuries, the yield curve remains steep, and I don't expect to see an increase in short-term rates for at least six to nine months.
The most interesting analogy I have seen regarding today's markets is in this weeekend's Barron's, where Michael Santoli, quoting Ned Davis Research, discusses the parallels between 2010 and 1962. Back then the Dow peaked on April 23, and sold off 17% by the end of May. The final bottom came in late June and was down 23% from the April high. 1962 was also the second year of a young Democratic president's term and had a backdrop of low interest rates and a "sturdy" economy.
STAYING WITH MLPs Broadly speaking I still like energy-related Master Limited Partnerships despite their in-line performance in May. I am focused on companies that are growing their distributable cash flow, can easily cover that distribution, who have little/no debt maturing in the next couple years, and who are hedged.
MLPs bounced back from the 2008 disaster and in many cases went on to set new highs. One subset that I track was down 41% in 2008, but then added 119% in 2009. And, owners continued to receive tax-advantaged dividends, with yields ranging from roughly 7-11% throughout the cycle.
MLPs appear to be trading with the price of oil, but the fundamentals are strong and I would expect to hold MLPs if we get a major selloff. I was able to (mostly) successfully hedge my single biggest income portfolio in May, a highly focused portfolio with only 10 positions, by shorting oil and the S&P 500 in the account. I will be looking to add to my oil short, as a hedge for the MLPs, in several other accounts that own them.
BAD BEHAVIOR: COINCIDENCE OR A PATTERN? In just the last couple weeks we've had stories that Goldman Sachs is negotiating with the SEC to plea to a lesser charge and thus avoid formal fraud charges in the ongoing investigation of its Abacus transaction. In addition, Reuters is reporting that Goldman told the California Pension Fund that it was not a target of any formal investigation, when, in fact, it had recently received a Wells Notice.
Also, Thomas Weisel Partners has been accused of selling $25mm of Auction Rate Preferred Stock out of their own book and into the accounts of three corporate customers, for the purpose of raising cash to pay employee bonuses. The allegation is that, since the public market for these securities was frozen, Weisel "stuffed" the securities where they could and let the customer deal with the illiquidity problem. (Note: Weisel has denied the charges)
Lastly, a few days ago Art Samberg, a veteran hedge fund manager, settled charges with the SEC that he had profited by $14.8 million by trading on insider information several years ago. He agreed to a $28 million fine and has also agreed to be barred from working as an investment advisor.
At one point these incidents would've been considered isolated and random. But more and more, behavior in the finacial markets reminds me of athletes taking performance enhancing drugs: everyone else is doing it and the ends justify the means. Shameful.
Please feel free to contact me with any questions or comments and let me know if you'd like to be removed from distribution.
May 2010
+
May 3, 2010
In April our range of returns was 1.9%-6.1%, and for the year the range of returns is 1.9%-10.5%. The S&P 500 returned 1.5% in April and for the year has returned 6.4%.
SOME GREAT EXECUTION
Several big holdings reported terrific results in April triggering nice gains. For example, KVHI reported 53% revenue growth and a pleasantly surprising 14 cents in eps, and the shares, despite an 8% drop on Friday, closed the month +13%. I expect more volatility in this name but it will remain a core holding in all portfolios.
Gold and silver were also strong performers in April, and I continue to own a 5-10% weighting in them in most portfolios. Gold is detaching itself from other commodities, and also its inverse relationship with the US dollar is fading. I also like that the ETFs for gold mining shares, GDX, and GDXJ, are trading well as they tend to lead gold (due to leverage). Silver is cheap to gold and I have been adding a bit to our SLV positions.
Most accounts also have one or two MLPs which continue to deliver outstanding results and share appreciation. Our biggest exposure is LINE, which reported a solid quarter and mentioned that they are 90% hedged through 2013. I own this name in most accounts and it is a big weighting in our income portfolios.
Our biggest bank position, WFC, returned 5% in April, and I remain optimistic about our positions in the money center banks.
M&A PICKS UP
The M&A calendar has been getting active again, and several transactions have been announced at reasonably large premiums. Some examples from the past couple months include APD's bid for ARG at a 38% premium, MRK's takeover of MIL at 50%, and just last week SF announced its intent to buy TWPG and HPQ announced a purchase of PALM at 70% and 23% premiums, respectively. Taken collectively, the significance to me is that corporations don't see the equity market as overvalued.
Additionally, we still have very low interest rates, a steep yield curve, and acceptable valuations. Also my sense, granted this is only from anecdotal evidence, is that many money managers are still cautious, and have underperformed this year. And there are still significant funds available, $2.9 trillion in money market mutual funds, according to this weeks's Barron's (Kopin Tan page M5).
Furthermore, earnings have been good, and we're even seeing pockets of revenue growth, not just cost cutting, to make numbers. So overall I am still fairly constructive and would expect pretty good support for the market if we get a 5% (or so) correction.
STARTING TO HEDGE
That said, in the past couple days we've seen some real volatility, and I wouldn't be surprised if we get a little pullback soon. I have a small hedge on the S&P 500 in a couple accounts, and am considering a hedge on the NASDAQ index as well.
To be clear, I am not expecting any significant damage, but a variety of items are suggesting near-term caution. As I've said many times, I'm much more interested in finding the right situations and being involved at the right prices, but nonetheless it's helpful to keep an eye on the overall environment.
In April I shorted a little LUFK, one of the names I was referring to last month. LUFK is a (mostly) oil services equipment provider that has risen from $28 last spring to a recent $89, just below its all-time high of $95 which coincided with $148 oil in 2008. Shares trade at roughly 65x trailing earnings, and 3x book, and while oil is down 40% from its peak, LUFK shares are only off 6%. Likewise the overall rig count is down, and LUFK's margins and backlog are down as well, although they each showed sequential improvement in the first quarter.
LUFK is a valuation call, not among my preferred reasons to short, and as usual it will be no more than 2% exposure per portfolio.
One other item to note is that the Chinese stock market is now down 20% from last year's peak, technically a bear market. This is noteworthy because China was the first index to turn around in late 2008, and the Shanghai index leads the CRB commodity spot price index by four months with a 72% correlation (Source David Rosenberg, April 28, 2010). I don't want to make too big a deal about this but I think it bears watching.
In April our range of returns was 1.9%-6.1%, and for the year the range of returns is 1.9%-10.5%. The S&P 500 returned 1.5% in April and for the year has returned 6.4%.
SOME GREAT EXECUTION
Several big holdings reported terrific results in April triggering nice gains. For example, KVHI reported 53% revenue growth and a pleasantly surprising 14 cents in eps, and the shares, despite an 8% drop on Friday, closed the month +13%. I expect more volatility in this name but it will remain a core holding in all portfolios.
Gold and silver were also strong performers in April, and I continue to own a 5-10% weighting in them in most portfolios. Gold is detaching itself from other commodities, and also its inverse relationship with the US dollar is fading. I also like that the ETFs for gold mining shares, GDX, and GDXJ, are trading well as they tend to lead gold (due to leverage). Silver is cheap to gold and I have been adding a bit to our SLV positions.
Most accounts also have one or two MLPs which continue to deliver outstanding results and share appreciation. Our biggest exposure is LINE, which reported a solid quarter and mentioned that they are 90% hedged through 2013. I own this name in most accounts and it is a big weighting in our income portfolios.
Our biggest bank position, WFC, returned 5% in April, and I remain optimistic about our positions in the money center banks.
M&A PICKS UP
The M&A calendar has been getting active again, and several transactions have been announced at reasonably large premiums. Some examples from the past couple months include APD's bid for ARG at a 38% premium, MRK's takeover of MIL at 50%, and just last week SF announced its intent to buy TWPG and HPQ announced a purchase of PALM at 70% and 23% premiums, respectively. Taken collectively, the significance to me is that corporations don't see the equity market as overvalued.
Additionally, we still have very low interest rates, a steep yield curve, and acceptable valuations. Also my sense, granted this is only from anecdotal evidence, is that many money managers are still cautious, and have underperformed this year. And there are still significant funds available, $2.9 trillion in money market mutual funds, according to this weeks's Barron's (Kopin Tan page M5).
Furthermore, earnings have been good, and we're even seeing pockets of revenue growth, not just cost cutting, to make numbers. So overall I am still fairly constructive and would expect pretty good support for the market if we get a 5% (or so) correction.
STARTING TO HEDGE
That said, in the past couple days we've seen some real volatility, and I wouldn't be surprised if we get a little pullback soon. I have a small hedge on the S&P 500 in a couple accounts, and am considering a hedge on the NASDAQ index as well.
To be clear, I am not expecting any significant damage, but a variety of items are suggesting near-term caution. As I've said many times, I'm much more interested in finding the right situations and being involved at the right prices, but nonetheless it's helpful to keep an eye on the overall environment.
In April I shorted a little LUFK, one of the names I was referring to last month. LUFK is a (mostly) oil services equipment provider that has risen from $28 last spring to a recent $89, just below its all-time high of $95 which coincided with $148 oil in 2008. Shares trade at roughly 65x trailing earnings, and 3x book, and while oil is down 40% from its peak, LUFK shares are only off 6%. Likewise the overall rig count is down, and LUFK's margins and backlog are down as well, although they each showed sequential improvement in the first quarter.
LUFK is a valuation call, not among my preferred reasons to short, and as usual it will be no more than 2% exposure per portfolio.
One other item to note is that the Chinese stock market is now down 20% from last year's peak, technically a bear market. This is noteworthy because China was the first index to turn around in late 2008, and the Shanghai index leads the CRB commodity spot price index by four months with a 72% correlation (Source David Rosenberg, April 28, 2010). I don't want to make too big a deal about this but I think it bears watching.
April 2010
+
April 4, 2010
In March, the range of our returns was +1.1%-+8.9%, and for the year the range is -11.6%-+6.8%. Returns for the S&P 500 were +5.9% and +4.9% respectively.
As I've stated, but it bears repeating as there are new readers evey month, these numbers aren't comparable, and I include the S&P only as a proxy for the overall market. The sizes, goals, risk parameters, weightings and investments of my accounts vary greatly. For example, my biggest account is 10x the size of my smallest one, and in the range of returns I include my personal account which has a significant exposure to one name, a name which is down ~15% year-to-date.
In addition, a few months ago I began offering an "income account" and currently about 25% of the assets I manage are pursuing that strategy. Rather than opening new accounts, clients added funds into existing ones, with the net result that what was already not an apples to apples comparison to the S&P is now even less so.
Income assets are invested in carefully selected Master Limited Partnerships, and several preferred and common stocks and ETFs, and at some point may even own a bond or two. I particularly like the MLPs, which pay a nice dividend, typically mid to high single digits, and have tax advantages as well. The importance of tax-advantaged investments may increase as it appears there will be higher tax rates in all our futures. I have been getting some good interest in my "Income" product, for which I charge 65 basis points annually.
Historically I have underperformed the S&P 500 in sharp upwards markets. However, I have more than made up for that by protecting assets in downturns. I guess you could say my defense has been much better than my offense.
SMALL CAP VOLATILITY
One of my favorite positons is Digimarc, a micro cap specializing in digital security and measurement. Pretty much every client owns shares, which I bought in late 2008 starting at $8. The shares have been a big performer, and when the company made an announcement in early March about a joint venture with Arbitron the shares bounced from just below $17 to $22, but then traded all the way back down to $17.25 at month end.
This volatility is not unusual in smaller names, and we own any number of them, largely because I like situations that are unknown and under followed as they tend to be more inefficienctly priced and thus there are opportunities for big returns. But they usually require patience and a strong stomach. Being able to invest in micro caps is among the reasons Peattie Capital manages separate accounts. Having, say, a $50mm fund would preclude investing in the Digimarcs of the world.
Another (not so small) example is BYD Co, a Chinese battery and car manufacturer which I mentioned a few times last year. I began buying shares last April near $3, and they too have been a big winner. But it has been a real roller coaster, with a surge to $11.25 in October followed by a 40% correction to $6.80 in February. Subsequently they rallied nearly 50% to $10 at month end, and were up another 4% Thursday. Most accounts only have 20 positions or so, and so this kind of volatility can really impact monthly performance.
I continue to like both these situations very much, and hope to own them for a long time, based on what I know today. At some point I may try to box the BYD shares again, which I was unable to do last fall as there was no borrow. Lest anyone think I only like smaller, less well known names, I should perhaps mention that most clients also own Berkshire Hathaway, Hewlett Packard and Schlumberger as well.
UNDER THE MICROSCOPE
I am not in the business of predicting short-term market direction, but I will point out that just prior to the last sell off, an 8% correction from mid January to early February, the VXO went below 16 and simultaneously the daily put/call ratio had several days below .70. So I am following these two items, and also looking at a couple other data points that sometimes coincide with a short term market top, like a couple days of early S&P futures highs and late day lows for example, or a significant (10 point) intraday futures reversal.
I think there is still tremendous fear out there, an abundance of liquidity, reasonable to good valuations, and a steep yield curve. My best guess is that, while we appear somewhat overbought here, and due for some kind of pullback, as long as earnings are growing the upwards trend will continue.
There are some items that do give me pause. First, some blue chip names are trading at seemingly low valuations, like IBM at 10x 2011 estimates, for example, well below the market's multiple. Simultaneously some crummy companies are trading pretty rich, like Capital One near 20x 2011 estimates. I'm not sure if there's a message in this but I think it bears watching.
Second, interest rates are backing up. Maybe it's my fixed income background, but I believe the bond market tends to lead the equity market and if there's significant weakness throughout the yield curve that may be a precursor to a weakening in equity markets. Third, some of the Fed's support programs are ending, and no one knows how these first few steps to remove liquidity will affect the market.
Regardless, my goal is to find the right situations and be involved at the right prices.
ODDS AND ENDS
For a while gold and the US dollar have been inversely correlated. That may be changing as the dollar is up about 4% this year, and gold is also up a bit, 1%. Every account has exposure to gold, somewhere in the 3-7% range, which I expect to hold. For me, gold is not about hedging against a weak US dollar but rather hedging against all fiat money, and other purposes. I couldn't tell you why the inverse relationship hasn't held this year, I am just observing that it hasn't.
Several situations I've looked at are tempting shorts, but so far I have yet to act on them. My favorite reasons to short are: 1) The company will unexpectedly miss earnings estimates and 2) the company's industry is changing, and incumbents can't/won't adapt.
Examples of the latter are Wal-Mart steamrolling through the retail industry or the internet upending the music and journalism industry. As to the former, it takes a very close following of a company to know that say, sales have dropped off somewhere, for example. Rallies like the one we're in demonstrate the danger of shorting based on a belief that a company is overvalued or the market overbought, in which case I'm more likely to simply avoid the name or raise cash. That said, don't be surprised to see a short or two or a little hedging in the near future, with any short kept pretty small, say in the 1-2% range.
Earnings season is here once again, and I am optimistic about the names we own.
In March, the range of our returns was +1.1%-+8.9%, and for the year the range is -11.6%-+6.8%. Returns for the S&P 500 were +5.9% and +4.9% respectively.
As I've stated, but it bears repeating as there are new readers evey month, these numbers aren't comparable, and I include the S&P only as a proxy for the overall market. The sizes, goals, risk parameters, weightings and investments of my accounts vary greatly. For example, my biggest account is 10x the size of my smallest one, and in the range of returns I include my personal account which has a significant exposure to one name, a name which is down ~15% year-to-date.
In addition, a few months ago I began offering an "income account" and currently about 25% of the assets I manage are pursuing that strategy. Rather than opening new accounts, clients added funds into existing ones, with the net result that what was already not an apples to apples comparison to the S&P is now even less so.
Income assets are invested in carefully selected Master Limited Partnerships, and several preferred and common stocks and ETFs, and at some point may even own a bond or two. I particularly like the MLPs, which pay a nice dividend, typically mid to high single digits, and have tax advantages as well. The importance of tax-advantaged investments may increase as it appears there will be higher tax rates in all our futures. I have been getting some good interest in my "Income" product, for which I charge 65 basis points annually.
Historically I have underperformed the S&P 500 in sharp upwards markets. However, I have more than made up for that by protecting assets in downturns. I guess you could say my defense has been much better than my offense.
SMALL CAP VOLATILITY
One of my favorite positons is Digimarc, a micro cap specializing in digital security and measurement. Pretty much every client owns shares, which I bought in late 2008 starting at $8. The shares have been a big performer, and when the company made an announcement in early March about a joint venture with Arbitron the shares bounced from just below $17 to $22, but then traded all the way back down to $17.25 at month end.
This volatility is not unusual in smaller names, and we own any number of them, largely because I like situations that are unknown and under followed as they tend to be more inefficienctly priced and thus there are opportunities for big returns. But they usually require patience and a strong stomach. Being able to invest in micro caps is among the reasons Peattie Capital manages separate accounts. Having, say, a $50mm fund would preclude investing in the Digimarcs of the world.
Another (not so small) example is BYD Co, a Chinese battery and car manufacturer which I mentioned a few times last year. I began buying shares last April near $3, and they too have been a big winner. But it has been a real roller coaster, with a surge to $11.25 in October followed by a 40% correction to $6.80 in February. Subsequently they rallied nearly 50% to $10 at month end, and were up another 4% Thursday. Most accounts only have 20 positions or so, and so this kind of volatility can really impact monthly performance.
I continue to like both these situations very much, and hope to own them for a long time, based on what I know today. At some point I may try to box the BYD shares again, which I was unable to do last fall as there was no borrow. Lest anyone think I only like smaller, less well known names, I should perhaps mention that most clients also own Berkshire Hathaway, Hewlett Packard and Schlumberger as well.
UNDER THE MICROSCOPE
I am not in the business of predicting short-term market direction, but I will point out that just prior to the last sell off, an 8% correction from mid January to early February, the VXO went below 16 and simultaneously the daily put/call ratio had several days below .70. So I am following these two items, and also looking at a couple other data points that sometimes coincide with a short term market top, like a couple days of early S&P futures highs and late day lows for example, or a significant (10 point) intraday futures reversal.
I think there is still tremendous fear out there, an abundance of liquidity, reasonable to good valuations, and a steep yield curve. My best guess is that, while we appear somewhat overbought here, and due for some kind of pullback, as long as earnings are growing the upwards trend will continue.
There are some items that do give me pause. First, some blue chip names are trading at seemingly low valuations, like IBM at 10x 2011 estimates, for example, well below the market's multiple. Simultaneously some crummy companies are trading pretty rich, like Capital One near 20x 2011 estimates. I'm not sure if there's a message in this but I think it bears watching.
Second, interest rates are backing up. Maybe it's my fixed income background, but I believe the bond market tends to lead the equity market and if there's significant weakness throughout the yield curve that may be a precursor to a weakening in equity markets. Third, some of the Fed's support programs are ending, and no one knows how these first few steps to remove liquidity will affect the market.
Regardless, my goal is to find the right situations and be involved at the right prices.
ODDS AND ENDS
For a while gold and the US dollar have been inversely correlated. That may be changing as the dollar is up about 4% this year, and gold is also up a bit, 1%. Every account has exposure to gold, somewhere in the 3-7% range, which I expect to hold. For me, gold is not about hedging against a weak US dollar but rather hedging against all fiat money, and other purposes. I couldn't tell you why the inverse relationship hasn't held this year, I am just observing that it hasn't.
Several situations I've looked at are tempting shorts, but so far I have yet to act on them. My favorite reasons to short are: 1) The company will unexpectedly miss earnings estimates and 2) the company's industry is changing, and incumbents can't/won't adapt.
Examples of the latter are Wal-Mart steamrolling through the retail industry or the internet upending the music and journalism industry. As to the former, it takes a very close following of a company to know that say, sales have dropped off somewhere, for example. Rallies like the one we're in demonstrate the danger of shorting based on a belief that a company is overvalued or the market overbought, in which case I'm more likely to simply avoid the name or raise cash. That said, don't be surprised to see a short or two or a little hedging in the near future, with any short kept pretty small, say in the 1-2% range.
Earnings season is here once again, and I am optimistic about the names we own.
March 2010
+
March 4, 2010
In February our range of returns was -1.1%-+3.7%, and the S&P 500 returned +2.9%. Our best performing portfolios were income oriented ones, which hold a variety of MLPs and a couple preferred stocks. In a repeat of January, it was my personal account, with a significant weighting in one name, which was the weakest performer. For the year, the range of returns is -7.0% - +4.7%, and the S&P 500 has returned -.90%.
EARNINGS HAVE BEEN GOOD
Most our names have reported year-end earnings and I am very happy with what I've heard. Among our biggest positions, PNI Networks had surprisingly good earnings and also announced that the Board has approved a share buyback. The company has also signed a contract with a major mobile phone manufacturer, although they witheld specific details on both these topics. In addition, the company has a $540,000 quarterly amortization expense resulting from an acquisition a few years ago which rolls off mid year. Since its low of 85 cents late in 2008 the shares have doubled, and I am optimistic there is more performance in front of us.
Berkshire Hathaway continues to report very good news and is still a good, not outstanding, value, unless this recovery turns out to be stronger than currently anticipated. No doubt there will be some backing and filling at some point but I anticipate holding the shares for the time being. Berkshire, with a market cap of roughly $195 billion, is our top performing name so far in 2010, with a gain of roughly 25% as of the March 3 close. Our second best performer is Digimarc, which has a market cap of $125mm and is up about 21% so far. Being able to buy both these names is one reason why I think Peattie Capital is a unique and compelling investment vehicle.
It looks like the correction in gold may be ending, and so I have begun removing the short side of our boxed GLD positions. In addition, I mentioned silver a couple months ago, and I still believe that silver represents a good opportunity because it has underpeformed gold the past several years and is at the low end of its historical relationship to gold, and because it has numerous (and increasing) industrial applications.
At the risk of sounding like a broken record I will say that I also liked what KVH Industries had to say, and was pleasantly surprised by the fourth quarter (and full year) earnings. Nonetheless, the shares continue to correct and are now down about 20% from their peak a few months ago. This is the name that I own in abundance in my personal account which has driven the -7% return so far this year.
For some accounts I have added a small position in Lexmark. I like this name because it trades below it's historical multiple range, and because I believe there is a good chance for a reasonably strong cyclical recovery in the printing industry that doesn't appear to be factored into market estimates at this point. Lexmark's earnings were well received in early February, and then Hewlett Packard also had good things to say about printing, especially with regards to demand. Lexmark currently trades at roughly 10x 2010 estimates and street consensus is that there will be no growth in 2010 over 2009, a view that I think is too conservative.
I have come across a few situations that look like they may be good shorting candidates as they have had huge moves and are now at extended valuations. So far I have held off, for a variety of reasons, but I think that the environment for shorting specific names may be setting up nicely after last year's "rising tide lifts all boats" market. As I've said several times, I think making money in 2010 will be more difficult than in 2009, and industry and stock selection will become more important.
Overall I am very pleased with the quality and content of our portfolio companies' reports and am optimistic about our prospects.
INFLATION?
I've been asked if I think inflation is a risk right now and my answer is no, I don't. Some of the signs I would look for just don't exist: for example, absolute rates in the US Government bond market are low (granted the curve is quite steep) as are the levels in the TIPS market. Second, I see various signs of deflation, including lower prices for many goods and assets, and overall slack in the economy as seen in the low rate of capacity utilization, and high unemployment, for example.
That being said, if the Fed maintains it's loose policies (and I believe they will) the odds increase that, eventually, inflation will appear. I don't anticipate hyper inflation, and, by virtue of the fact that people are discussing its possibility, I don't see unanticipated inflation either, and these two types of inflation would be the most challenging to equity investors. Generally speaking, a bit of inflation is a good thing for equities, and wouldn't alter my approach which is to find the right securities and pay the right price for them. Several names I own would probably do well in an inflationary backdrop, although that is not why I own them. In addition to gold and silver, I have a couple positions in oil and gas and other natural resources and basic materials.
BUFFETT'S LETTER
Buffett's annual letter was published over the weekend. It is a terrific read, and has the usual hokey humor and insights into a variety of industries. There have been any number of news summaries and comments on "the best Buffett line this year". I haven't yet seen anything in the media discussing Buffett's blistering comments about the media themselves, in which he takes them to task over their selectivity and sensationalism, exemplified by their reporting of one sentence from the previous (2008) letter. In that sentence Buffett wrote: "We are certain, for example, that the economy will be in shambles throughout 2009-and probably well beyond-but that conclusion does not tell us whether the market will rise or fall."
The news organizations, Buffett states, "reported-indeed, blared-the first part of the sentence while making no mention whatsoever of its ending. I regard this as terrible journalism...." Buffett goes on to make it clear that this is not the only time Berkshire and its shareholders have been subject to shoddy and irresponsible journalism. I'm pretty sure it won't be the last, either.
In February our range of returns was -1.1%-+3.7%, and the S&P 500 returned +2.9%. Our best performing portfolios were income oriented ones, which hold a variety of MLPs and a couple preferred stocks. In a repeat of January, it was my personal account, with a significant weighting in one name, which was the weakest performer. For the year, the range of returns is -7.0% - +4.7%, and the S&P 500 has returned -.90%.
EARNINGS HAVE BEEN GOOD
Most our names have reported year-end earnings and I am very happy with what I've heard. Among our biggest positions, PNI Networks had surprisingly good earnings and also announced that the Board has approved a share buyback. The company has also signed a contract with a major mobile phone manufacturer, although they witheld specific details on both these topics. In addition, the company has a $540,000 quarterly amortization expense resulting from an acquisition a few years ago which rolls off mid year. Since its low of 85 cents late in 2008 the shares have doubled, and I am optimistic there is more performance in front of us.
Berkshire Hathaway continues to report very good news and is still a good, not outstanding, value, unless this recovery turns out to be stronger than currently anticipated. No doubt there will be some backing and filling at some point but I anticipate holding the shares for the time being. Berkshire, with a market cap of roughly $195 billion, is our top performing name so far in 2010, with a gain of roughly 25% as of the March 3 close. Our second best performer is Digimarc, which has a market cap of $125mm and is up about 21% so far. Being able to buy both these names is one reason why I think Peattie Capital is a unique and compelling investment vehicle.
It looks like the correction in gold may be ending, and so I have begun removing the short side of our boxed GLD positions. In addition, I mentioned silver a couple months ago, and I still believe that silver represents a good opportunity because it has underpeformed gold the past several years and is at the low end of its historical relationship to gold, and because it has numerous (and increasing) industrial applications.
At the risk of sounding like a broken record I will say that I also liked what KVH Industries had to say, and was pleasantly surprised by the fourth quarter (and full year) earnings. Nonetheless, the shares continue to correct and are now down about 20% from their peak a few months ago. This is the name that I own in abundance in my personal account which has driven the -7% return so far this year.
For some accounts I have added a small position in Lexmark. I like this name because it trades below it's historical multiple range, and because I believe there is a good chance for a reasonably strong cyclical recovery in the printing industry that doesn't appear to be factored into market estimates at this point. Lexmark's earnings were well received in early February, and then Hewlett Packard also had good things to say about printing, especially with regards to demand. Lexmark currently trades at roughly 10x 2010 estimates and street consensus is that there will be no growth in 2010 over 2009, a view that I think is too conservative.
I have come across a few situations that look like they may be good shorting candidates as they have had huge moves and are now at extended valuations. So far I have held off, for a variety of reasons, but I think that the environment for shorting specific names may be setting up nicely after last year's "rising tide lifts all boats" market. As I've said several times, I think making money in 2010 will be more difficult than in 2009, and industry and stock selection will become more important.
Overall I am very pleased with the quality and content of our portfolio companies' reports and am optimistic about our prospects.
INFLATION?
I've been asked if I think inflation is a risk right now and my answer is no, I don't. Some of the signs I would look for just don't exist: for example, absolute rates in the US Government bond market are low (granted the curve is quite steep) as are the levels in the TIPS market. Second, I see various signs of deflation, including lower prices for many goods and assets, and overall slack in the economy as seen in the low rate of capacity utilization, and high unemployment, for example.
That being said, if the Fed maintains it's loose policies (and I believe they will) the odds increase that, eventually, inflation will appear. I don't anticipate hyper inflation, and, by virtue of the fact that people are discussing its possibility, I don't see unanticipated inflation either, and these two types of inflation would be the most challenging to equity investors. Generally speaking, a bit of inflation is a good thing for equities, and wouldn't alter my approach which is to find the right securities and pay the right price for them. Several names I own would probably do well in an inflationary backdrop, although that is not why I own them. In addition to gold and silver, I have a couple positions in oil and gas and other natural resources and basic materials.
BUFFETT'S LETTER
Buffett's annual letter was published over the weekend. It is a terrific read, and has the usual hokey humor and insights into a variety of industries. There have been any number of news summaries and comments on "the best Buffett line this year". I haven't yet seen anything in the media discussing Buffett's blistering comments about the media themselves, in which he takes them to task over their selectivity and sensationalism, exemplified by their reporting of one sentence from the previous (2008) letter. In that sentence Buffett wrote: "We are certain, for example, that the economy will be in shambles throughout 2009-and probably well beyond-but that conclusion does not tell us whether the market will rise or fall."
The news organizations, Buffett states, "reported-indeed, blared-the first part of the sentence while making no mention whatsoever of its ending. I regard this as terrible journalism...." Buffett goes on to make it clear that this is not the only time Berkshire and its shareholders have been subject to shoddy and irresponsible journalism. I'm pretty sure it won't be the last, either.
February 2010
+
February 2, 2010
In January the range of returns on our portfolios was -12.8%-+3.8%, and the overall group number was -2.3%. The S&P 500 returned -3.7%.
I am considering omitting a collective performance number as it is confusing, and arguably irrelevant. Peattie Capital runs separate portfolios for its clients, each with its own goals, circumstances, time horizon, risk profile, etc., and so portfolios look very different from one another in terms of number of positions, weighting in a specific name or industry, tactical trading activity, hedging, and shorting. My personal IRA has only five positions (it was the low performer in January) and a couple others have only eight or nine positions. Most portfolios have 15-25 positions, and none has more than that.
Last month I mentioned setting up a surrogate bond account for a few clients, and in these cases I have about 10 names, which were added into pre-existing portfolios. So even within portfolios there are now different goals blended together. A fund clearly produces a single return over a specific time frame, but combining the results of varied separate accounts together into one aggregate number doesn't really tell anyone anything, and I seem to spend an inordinate amount of time disaggregating and explaining it.
For all clients my overarching goals are to focus on long-term performance, to avoid major losses, to provide the highest level of service and transparency, and to always act in the best interest of the client.
WINNERS AND LOSERS
We had terrific performance from BRK, one of our top positions, which jumped after the announcement it will be added to the S&P 500 index. Not that I am complaining, but being added to the index wasn't among the reasons for owning the shares. I expect to continue holding BRK and may sell some covered calls on the position as a way to generate a little income if the shares keep rallying. In my November letter I mentioned that I had been buying HNZ, which was also a good performer in January. Another name I have mentioned repeatedly is SCPZF, which gained 3% on the month, and I am particularly excited about this position and expect to add more shares.
On the other side of the ledger, KVHI traded down nearly 15%. As far as I 'm concerned, the weak performance has nothing to do with the fundamentals or opportunity for KVH (note that many of last year's top performers were weak in January). I visited with a KVH executive at the NYC Boat Show a week ago and remain convinced that the opportunity for this company is huge and that commercial acceptance of its Tracphone v7 product is developing nicely. KVH is already a significant position in every account, however it is tempting to add even more shares for my most aggressive accounts as I think making money in the stock market in 2010 will be much more challenging than it was in 2009. As Warren Buffett says, (I'm paraphrasing here) "Wait for the fat pitch and when you see it take a big cut".
Gold and silver were also weak, but so far I see no reason to change my holdings in them. I recently heard the overall financial condition of the United States described as "cancerous", and whether you believe that or not, there is no doubt there are serious issues. Recent dollar strength is a near-term headwind for gold (and any company with significant international operations) but I view this strength as a result of things being even worse for some other major currencies.
DOWN JANUARY MEANS DOWN YEAR?
Who knows? This "tell" and other rules of thumb are fine and work....except when they don't. I think January is a particularly tricky month, because of the numerous cross currents involving profit taking, rebalancing, and re-allocating after year end. Most accounts were pretty quiet in January, although I did raise some cash and add a little SCPZF in a couple cases. Regardless, I'm much more interested in finding the right situation and getting involved at the right price.
That being said, the market is clearly responding less favorably to what appears to be reasonably good news. Recent examples are earnings reports from AMZN, INTC, MSFT, a favorable GDP report, and the re-election of Bernanke to another term. The GDP report has holes in it, like the slowdown in the pace of inventory reduction, for example, without which GDP would've only grown at a 2.2% annual rate (Source David Rosenberg 1/29/10). Nonetheless it does represent a second consecutive quarter of growth. The same reasons the bulls have been bullish and the bears bearish are still in place, as best I can see, although there seems to be more acceptance of the idea that growth will be slower than usual coming out of a recession.
Generally speaking, selling into good news gives me pause, and I am also mildly concerned by the fact that the S&P futures haven't had consecutive daily gains since Jan. 13, and that the VXO troughed at 16 on Jan. 19, a level not seen since July, 2008, shortly before the market's collapse.
Unlike last year, I think 2010 will provide much more opportunity for a skilled money manager to demonstrate his/her strengths. Stock picking will play a bigger role in generating returns than it did last year when the single most important decision was to get long after the March bottom. I expect this year to be more of a roller coaster, a gentle one, but a bit bumpy nonetheless, possibly worse when we see what the timing and pace of the Fed's liquidity withdrawal looks like.
PRIVATE EQUITY: BACK TO NORMAL
"Dividend" or "leveraged" recapitalizations have been extremely popular with the private equity crowd over the past several years. During this time, private equity groups bought companies, and immediately loaded them up with debt, the proceeds of which were used, at least in part, to pay themselves a big, up-front dividend. In 2006 and 2007, such dividends totalled $56 billion, according to this weekend's WSJ. This game disappeared with the credit crunch, but recently it started up again, with payments totalling $2.1billion in January (ibid).
When Dollar General was taken private by KKR, Citigroup, and Goldman in 2007 it had $2.7bn of debt, and when it came public again in November 2009 it had $4.2bn of debt, with interest payments alone chewing up 39% of operating income. Furthermore, the private equity groups paid themselves a one-time dividend of $239mm right before the IPO, more than twice what DG earned that quarter, even though as a public company DG pays no dividend.
Another example is HCA, the nation's largest hospital chain, which was taken private by KKR, Bain, Merrill Lynch, and members of the founding Frist family in 2006. HCA has just announced that it will pay its owners a one-time $1.75 billion dividend, after strong 2009 results.
Maybe the so-called "new" normal isn't so new after all. Oh, and don't expect to see any DG (or HCA, when it comes public) in any of PCM's portfolios.
In January the range of returns on our portfolios was -12.8%-+3.8%, and the overall group number was -2.3%. The S&P 500 returned -3.7%.
I am considering omitting a collective performance number as it is confusing, and arguably irrelevant. Peattie Capital runs separate portfolios for its clients, each with its own goals, circumstances, time horizon, risk profile, etc., and so portfolios look very different from one another in terms of number of positions, weighting in a specific name or industry, tactical trading activity, hedging, and shorting. My personal IRA has only five positions (it was the low performer in January) and a couple others have only eight or nine positions. Most portfolios have 15-25 positions, and none has more than that.
Last month I mentioned setting up a surrogate bond account for a few clients, and in these cases I have about 10 names, which were added into pre-existing portfolios. So even within portfolios there are now different goals blended together. A fund clearly produces a single return over a specific time frame, but combining the results of varied separate accounts together into one aggregate number doesn't really tell anyone anything, and I seem to spend an inordinate amount of time disaggregating and explaining it.
For all clients my overarching goals are to focus on long-term performance, to avoid major losses, to provide the highest level of service and transparency, and to always act in the best interest of the client.
WINNERS AND LOSERS
We had terrific performance from BRK, one of our top positions, which jumped after the announcement it will be added to the S&P 500 index. Not that I am complaining, but being added to the index wasn't among the reasons for owning the shares. I expect to continue holding BRK and may sell some covered calls on the position as a way to generate a little income if the shares keep rallying. In my November letter I mentioned that I had been buying HNZ, which was also a good performer in January. Another name I have mentioned repeatedly is SCPZF, which gained 3% on the month, and I am particularly excited about this position and expect to add more shares.
On the other side of the ledger, KVHI traded down nearly 15%. As far as I 'm concerned, the weak performance has nothing to do with the fundamentals or opportunity for KVH (note that many of last year's top performers were weak in January). I visited with a KVH executive at the NYC Boat Show a week ago and remain convinced that the opportunity for this company is huge and that commercial acceptance of its Tracphone v7 product is developing nicely. KVH is already a significant position in every account, however it is tempting to add even more shares for my most aggressive accounts as I think making money in the stock market in 2010 will be much more challenging than it was in 2009. As Warren Buffett says, (I'm paraphrasing here) "Wait for the fat pitch and when you see it take a big cut".
Gold and silver were also weak, but so far I see no reason to change my holdings in them. I recently heard the overall financial condition of the United States described as "cancerous", and whether you believe that or not, there is no doubt there are serious issues. Recent dollar strength is a near-term headwind for gold (and any company with significant international operations) but I view this strength as a result of things being even worse for some other major currencies.
DOWN JANUARY MEANS DOWN YEAR?
Who knows? This "tell" and other rules of thumb are fine and work....except when they don't. I think January is a particularly tricky month, because of the numerous cross currents involving profit taking, rebalancing, and re-allocating after year end. Most accounts were pretty quiet in January, although I did raise some cash and add a little SCPZF in a couple cases. Regardless, I'm much more interested in finding the right situation and getting involved at the right price.
That being said, the market is clearly responding less favorably to what appears to be reasonably good news. Recent examples are earnings reports from AMZN, INTC, MSFT, a favorable GDP report, and the re-election of Bernanke to another term. The GDP report has holes in it, like the slowdown in the pace of inventory reduction, for example, without which GDP would've only grown at a 2.2% annual rate (Source David Rosenberg 1/29/10). Nonetheless it does represent a second consecutive quarter of growth. The same reasons the bulls have been bullish and the bears bearish are still in place, as best I can see, although there seems to be more acceptance of the idea that growth will be slower than usual coming out of a recession.
Generally speaking, selling into good news gives me pause, and I am also mildly concerned by the fact that the S&P futures haven't had consecutive daily gains since Jan. 13, and that the VXO troughed at 16 on Jan. 19, a level not seen since July, 2008, shortly before the market's collapse.
Unlike last year, I think 2010 will provide much more opportunity for a skilled money manager to demonstrate his/her strengths. Stock picking will play a bigger role in generating returns than it did last year when the single most important decision was to get long after the March bottom. I expect this year to be more of a roller coaster, a gentle one, but a bit bumpy nonetheless, possibly worse when we see what the timing and pace of the Fed's liquidity withdrawal looks like.
PRIVATE EQUITY: BACK TO NORMAL
"Dividend" or "leveraged" recapitalizations have been extremely popular with the private equity crowd over the past several years. During this time, private equity groups bought companies, and immediately loaded them up with debt, the proceeds of which were used, at least in part, to pay themselves a big, up-front dividend. In 2006 and 2007, such dividends totalled $56 billion, according to this weekend's WSJ. This game disappeared with the credit crunch, but recently it started up again, with payments totalling $2.1billion in January (ibid).
When Dollar General was taken private by KKR, Citigroup, and Goldman in 2007 it had $2.7bn of debt, and when it came public again in November 2009 it had $4.2bn of debt, with interest payments alone chewing up 39% of operating income. Furthermore, the private equity groups paid themselves a one-time dividend of $239mm right before the IPO, more than twice what DG earned that quarter, even though as a public company DG pays no dividend.
Another example is HCA, the nation's largest hospital chain, which was taken private by KKR, Bain, Merrill Lynch, and members of the founding Frist family in 2006. HCA has just announced that it will pay its owners a one-time $1.75 billion dividend, after strong 2009 results.
Maybe the so-called "new" normal isn't so new after all. Oh, and don't expect to see any DG (or HCA, when it comes public) in any of PCM's portfolios.
January 2010
+
January 9, 2010
In December the range of returns for our portfolios was +2.7%-+9.7% and collectively we returned +4.0%. The S&P 500 returned +1.8%. For the year, the range of PCM's returns was +5.6%-+26.2%, and our collective return was +15.4%. The S&P 500 returned +23.5%, dividend excluded.
GOLD VS. S&P 500
Gold rose 23% in 2009, its 10th consecutive annual increase. Since the end of 2000, spot gold has risen from $273 to $1,096. During this period, the S&P 500 has dropped from 1,320 to 1,115, its worst decade ever. I'm not sure exactly what this means, but my belief is that the Fed and most Central Banks will keep the liquidity spigots open, and pressure will continue on many fiat currencies. I boxed about two-thirds of our GLD position in early December, and am slowly buying back the short side of the box. We also own CEF and SCPZF as gold plays, and broadly speaking, I also like other precious metals and commodities. On at least a trading basis, I am adding silver (via SLV) in most accounts as it is trading well below it's historical relationship to gold and also has commercial uses which may support demand if the economy continues to improve.
INCOME, INCOME, INCOME
One terrific sector last year was Master Limited Partnerships (MLPs) which pay hefty dividends, typically in the 7-9% range. In 2009, many of them also had significant price appreciation, and had total returns in the 50% area, sometimes more. That won't happen again in 2010, but there is still some good value here, and I have been speaking to clients and prospects about setting up a surrogate fixed income portfolio, consisting of a variety of MLPs and a few other dividend payers. The idea is to produce after-tax gains that outperform other fixed income products, a bar that's pretty low given where interest rates are. MLPs have a "return of capital" component to the dividend, which means that only a portion of the dividend is taxed, and the rest of it is used to reduce the original cost basis. When the security is sold, the taxable gain is larger, but clients can hold the security for years, delaying the tax payment or even avoiding it if the security is included in estate planning. I am not an accountant and PCM does not give tax advice, so I suggest anyone interested check with their accountant if this idea looks appealing.
There are also diversification benefits as well, which could be important to anyone with a significant municipal bond portfolio, especially when you consider that something like 36 states are running budget deficits.
Needless to say this is not a risk-free strategy, but for a small portion of a fixed income portfolio it may make some sense. PCM already owns several MLPs, and for a few clients I have carved out a piece of their account dedicated to this strategy and for that piece I am charging 0.65% annually.
STOCK SELECTION CRITICAL
In last month's letter I mentioned the money center banks, and I continue to own WFC, JPM, and BAC for most accounts. I also mentioned KVHI, a micro cap which appears to be on the cusp of some serious earnings growth, and I nibbled a few more shares there. I recently came across another micro cap, below $400mm, which trades at 4x earnings, 60% of tangible book value, has been using its cash flow to buy back shares and debt, and yields 8.7%. I am looking forward to studying this situation more closely.
Most accounts also own a material position in BRK, which is trading at the lower end of its historical range (1.2x book value), and I think book will prove to be higher than expected as a result of Buffett's timely deployment of cash over the past year. In addition, BRK gives us exposure to a variety of industries and provides some ballast in several portfolios who own a myriad of small and micro cap names.
I don't have much going on in energy right now, (excluding the MLPs) but expect to be involved again soon, and am focusing on oilfield services in the oil sector and services as well as equipment providers in the natural gas industry as they will be in demand as the shale story progresses.
On the short side I have been extremely quiet; save for the boxed gold position I haven't shorted anything for months. I would expect that volatility may pick up a bit and there may be some shorting or hedging soon.
BULLS VS. BEARS
I'm really more interested in finding good companies at good prices, but knowing (well, having an opinion on) the environment is important too. Bears maintain that we are in the midst of a bear-market rally, which is destined to fail when liquidity is withdrawn. They cite deflation, (note the collapse in money volatility), a stubbornly uncomfortable unemployment rate (over 17% using the u-6 data), earnings stability resulting from expense control (read: job cuts) rather than genuine revenue growth, the unaddressed commercial real estate issue ($1.6 trillion in mortgage debt matures in the next five years in the US), a potential slowdown in China, rising home foreclosures and personal bankruptcies, the intractable debt burden and associated debt servicing costs facing the US (in the next 12 months the US has to refinance $2 trillion in short-term debt and estimates are that there will be another $1.5 trillion in deficit spending according to Richard Russell, 12/7/09), and a slower than normal recovery coming out of the recession, particularly troublesome given all the stimuli provided by Washington.
On the positive side, the steep yield curve has been a bullish signal for risk assets in the past, including resuscitating the economy from recessions in 1982-84, 1992, and 2002-2003. In addition, the aforementioned liquidity will keep flowing into the system, and history says that bull markets don't end after nine months. For those who believe in mean reversion, the past decade's dreadful performance by the S&P 500 is about as good a signal as you can get, and last year the S&P 500 had it's worst relative performance to corporate bonds in the past 40 years (Source: B of A/Merrill Lynch, 12/6/09).
The most bullish strategist I follow, Don Hays, suggests that earnings growth should return to its median trend line, and he extrapolates that 20 months from now, the forward 12-month earnings will be $109, barely 10x year-end's 1115 (morning comments 1/4/10). Other earnings estimates vary: on a "bottoms up" basis the 2010 estimate is $77.74 and on a "top-down" basis it is $73.45 (Hays 12/28/09).
The most bearish strategist I follow, David Rosenberg of Gluskin Sheff, thinks that the $77 figure being used is unrealistic, given that 2009's earnings are probably going to be in the mid to high $50s. Absent a big jump in GDP, a 35% increase (roughly) in earnings is unlikely, and he is thinking more in the $62 range.
One wild card is the manner in which the Fed begins to withdraw liquidity, but at the December meeting (minutes released Jan. 6), several committee members suggested expanding and extending quantitative easing beyond the first quarter, which reinforces to me that the Fed is in no hurry to remove its liquidity support. In addition to the unemployment figures, the subdued recovery, and little (so far) inflation, there is also the precedent of 1938 when the Fed's decision to tighten is widely viewed as a mistake.
I will be watching the Fed's language closely, as a change there will precede an actual tightening. I am also watching the bond markets closely, as I believe the Fed can maintain the status quo, whereby Treasury borrows unlimited amounts of money and the Fed continues to buy mortgages and other debt, as long as the bond market says it can. Indigestion in the bond markets might signal that this process is no longer viable, and any of these events could trigger some serious volatility in the markets.
In December the range of returns for our portfolios was +2.7%-+9.7% and collectively we returned +4.0%. The S&P 500 returned +1.8%. For the year, the range of PCM's returns was +5.6%-+26.2%, and our collective return was +15.4%. The S&P 500 returned +23.5%, dividend excluded.
GOLD VS. S&P 500
Gold rose 23% in 2009, its 10th consecutive annual increase. Since the end of 2000, spot gold has risen from $273 to $1,096. During this period, the S&P 500 has dropped from 1,320 to 1,115, its worst decade ever. I'm not sure exactly what this means, but my belief is that the Fed and most Central Banks will keep the liquidity spigots open, and pressure will continue on many fiat currencies. I boxed about two-thirds of our GLD position in early December, and am slowly buying back the short side of the box. We also own CEF and SCPZF as gold plays, and broadly speaking, I also like other precious metals and commodities. On at least a trading basis, I am adding silver (via SLV) in most accounts as it is trading well below it's historical relationship to gold and also has commercial uses which may support demand if the economy continues to improve.
INCOME, INCOME, INCOME
One terrific sector last year was Master Limited Partnerships (MLPs) which pay hefty dividends, typically in the 7-9% range. In 2009, many of them also had significant price appreciation, and had total returns in the 50% area, sometimes more. That won't happen again in 2010, but there is still some good value here, and I have been speaking to clients and prospects about setting up a surrogate fixed income portfolio, consisting of a variety of MLPs and a few other dividend payers. The idea is to produce after-tax gains that outperform other fixed income products, a bar that's pretty low given where interest rates are. MLPs have a "return of capital" component to the dividend, which means that only a portion of the dividend is taxed, and the rest of it is used to reduce the original cost basis. When the security is sold, the taxable gain is larger, but clients can hold the security for years, delaying the tax payment or even avoiding it if the security is included in estate planning. I am not an accountant and PCM does not give tax advice, so I suggest anyone interested check with their accountant if this idea looks appealing.
There are also diversification benefits as well, which could be important to anyone with a significant municipal bond portfolio, especially when you consider that something like 36 states are running budget deficits.
Needless to say this is not a risk-free strategy, but for a small portion of a fixed income portfolio it may make some sense. PCM already owns several MLPs, and for a few clients I have carved out a piece of their account dedicated to this strategy and for that piece I am charging 0.65% annually.
STOCK SELECTION CRITICAL
In last month's letter I mentioned the money center banks, and I continue to own WFC, JPM, and BAC for most accounts. I also mentioned KVHI, a micro cap which appears to be on the cusp of some serious earnings growth, and I nibbled a few more shares there. I recently came across another micro cap, below $400mm, which trades at 4x earnings, 60% of tangible book value, has been using its cash flow to buy back shares and debt, and yields 8.7%. I am looking forward to studying this situation more closely.
Most accounts also own a material position in BRK, which is trading at the lower end of its historical range (1.2x book value), and I think book will prove to be higher than expected as a result of Buffett's timely deployment of cash over the past year. In addition, BRK gives us exposure to a variety of industries and provides some ballast in several portfolios who own a myriad of small and micro cap names.
I don't have much going on in energy right now, (excluding the MLPs) but expect to be involved again soon, and am focusing on oilfield services in the oil sector and services as well as equipment providers in the natural gas industry as they will be in demand as the shale story progresses.
On the short side I have been extremely quiet; save for the boxed gold position I haven't shorted anything for months. I would expect that volatility may pick up a bit and there may be some shorting or hedging soon.
BULLS VS. BEARS
I'm really more interested in finding good companies at good prices, but knowing (well, having an opinion on) the environment is important too. Bears maintain that we are in the midst of a bear-market rally, which is destined to fail when liquidity is withdrawn. They cite deflation, (note the collapse in money volatility), a stubbornly uncomfortable unemployment rate (over 17% using the u-6 data), earnings stability resulting from expense control (read: job cuts) rather than genuine revenue growth, the unaddressed commercial real estate issue ($1.6 trillion in mortgage debt matures in the next five years in the US), a potential slowdown in China, rising home foreclosures and personal bankruptcies, the intractable debt burden and associated debt servicing costs facing the US (in the next 12 months the US has to refinance $2 trillion in short-term debt and estimates are that there will be another $1.5 trillion in deficit spending according to Richard Russell, 12/7/09), and a slower than normal recovery coming out of the recession, particularly troublesome given all the stimuli provided by Washington.
On the positive side, the steep yield curve has been a bullish signal for risk assets in the past, including resuscitating the economy from recessions in 1982-84, 1992, and 2002-2003. In addition, the aforementioned liquidity will keep flowing into the system, and history says that bull markets don't end after nine months. For those who believe in mean reversion, the past decade's dreadful performance by the S&P 500 is about as good a signal as you can get, and last year the S&P 500 had it's worst relative performance to corporate bonds in the past 40 years (Source: B of A/Merrill Lynch, 12/6/09).
The most bullish strategist I follow, Don Hays, suggests that earnings growth should return to its median trend line, and he extrapolates that 20 months from now, the forward 12-month earnings will be $109, barely 10x year-end's 1115 (morning comments 1/4/10). Other earnings estimates vary: on a "bottoms up" basis the 2010 estimate is $77.74 and on a "top-down" basis it is $73.45 (Hays 12/28/09).
The most bearish strategist I follow, David Rosenberg of Gluskin Sheff, thinks that the $77 figure being used is unrealistic, given that 2009's earnings are probably going to be in the mid to high $50s. Absent a big jump in GDP, a 35% increase (roughly) in earnings is unlikely, and he is thinking more in the $62 range.
One wild card is the manner in which the Fed begins to withdraw liquidity, but at the December meeting (minutes released Jan. 6), several committee members suggested expanding and extending quantitative easing beyond the first quarter, which reinforces to me that the Fed is in no hurry to remove its liquidity support. In addition to the unemployment figures, the subdued recovery, and little (so far) inflation, there is also the precedent of 1938 when the Fed's decision to tighten is widely viewed as a mistake.
I will be watching the Fed's language closely, as a change there will precede an actual tightening. I am also watching the bond markets closely, as I believe the Fed can maintain the status quo, whereby Treasury borrows unlimited amounts of money and the Fed continues to buy mortgages and other debt, as long as the bond market says it can. Indigestion in the bond markets might signal that this process is no longer viable, and any of these events could trigger some serious volatility in the markets.
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