NEWSPAPER READING & MACRO PICTURE - Q1/2024

WEB claims that thinking about macro is waste of time. However, he spends a few hours per day reading newspapers (vaguely remember that it could be even 3-4 hours daily). Somehow I cannot force myself to pay for content when there are plenty of free quality content and I would simply have no mental processing capacity to read more if I buy additional daily readings. I spend roughly 2 hours per day on "newspapers" and X. It took me more than 20 years to figure out what is useful to read and definitely it is different for every person. Those few hours is probably 70% macro, 30% business news. A few days after reading I do not remember almost anything what I read but still hope that something is sticking to the wall. You really need only one or two good insights per year.

Times are unclear and hopefully not nuclear. So far so good. The storm is coming - since 2009. In 2020 seemed like it's here. Still, bank strategists are very afraid of 2000 and 2008.

For those with ADD, fiscal policy so far is winning: 

[QT + Interest Rates] < [Budget Deficits + FED's talks]

Longer version: 

QT (-$1.4T from peak, $7.5B remain) + Interest rates (net interest for non financials in Q4/24 hit Q2/99 level and going down) < $2T budget deficit (NOW, in $23T economy) + Fed's talk (vague promise to cut acts as "Powel's Put"). Mr. Market is saying that if troubles start surfacing, QT/interest induced constrains are easily removable. Major central banks are shrinking balance sheet at roughly annual 8-10% pace. With success.

Last few weeks have brought a number of very good posts on bi-polar facts, which well explains no need for rate hikes. Last week the FED/ECB "promised" something in June. My take is that June will become September. Cuts were promised and priced in, therefore, there should be - at least 1, though it's 50/50. It's the election year.. In 2007, circumstances were different but the first cut was in September, after 9 no action meetings, 15 months after maxing out. In 2023, the last increase was in June.

Essence is always in risk vs. reward and position sizing. My take is that probably now we have a similar probability of sustained 20% jump and 30% fall in S&P (even 50% would be understandable in the latter case but so far nobody came up with a bull thesis and bear is simply not working). The US health for the next 6 months seems perfectly intact. 

5% risk free is a very good deal at the moment. 10%+ listed 1x leveraged senior/junior portfolios also look attractive (OCSL and similar). I also like dry powder they have for any dislocations. Leverage now simply pays for the high management fees.

I cannot do much because 2/3 of money are tied in private investments but 1/2 of the remaining 1/3 is yielding safely (almost) 7-8% weighted. It's good that I do not have to solve another 1/3 problem.

WHAT WOULD I DO IF I WAS THE FED?

This year is a reminder that Mr. Market is the Almighty. Greed. Fear. Luck. Misfortune. What is simply accident and was is a real skill? Remember Hugh Hendry and his intellectual torture. Pleasure to read but useless otherwise. At least, so far.

In such a market no stock goes down without a proper reason. I am very curious to know what Michael Burry is doing these days. Is he also a part of a survivor's bias? Such thoughts are haunting me after a few investing setbacks. I think that mainly all heroes of Free Capital are simple survivors as for each one there are hundreds or thousands of those who did not make it. On the other hand, what do I know... there are guys from Graham-and-Doddsville. I did not see any pattern in Free Capital except that almost all of them had ten baggers, which set them free, meaning those were significant positions. For every big position, which worked 10 times there are thousand times more big positions, which has not worked.

Emotions aside, what would I do if I was the FED? I would love to know what is the tolerance of the market without risking too much to create an irreversible downward trends. It is easier said than done but something must be tried. Theoretically, the Fed can backstop at any market level. Practically, it is difficult to say.

But back to the question, what would I do?

a) I would pretend that everything is fine as long as possible; (e.g. perform stress test and find out that only 30b is needed to fix it all);
b) I would not let the new reality to set in ("muddle through" is good enough but "going down" - especially risking to reach the point of no return - is not affordable);
c) I would "slightly" manage statistics in case market overreacts downwards and fine tune later - similar to how GDP numbers are being "perfected" for a number of years.

The bad reality is that muddle through is not possible for too long (think 10 years) and this is the tragedy, which will cause another can kicking moment and potentially (4% probability) a full blow up of the system later. However, I think that money are on irreversible trend of losing value and the slowness of the process will cause the system to be in manageable equilibrium to infinity. I would place 4% probability to "nuclear" scenario and 96% to slow decay of money. It is nice to imagine, read and think about this "nuclear" case but it is not very probable. External shock could be a driver and it is the biggest unknown risk but this is normal (think about Buffett's fear of nuclear attack, Ebola expands exponentially, and similar).

Well, I think QE 4 and 5 is on the way but what is the level of S&P for that - this is the question? 1900? 1700? 1500? 1500 looks reasonable for me but could be too risky and too late, therefore, 1800 is probably a nice average to bear in mind. Well, I will note to myself that 2014 will be marked by indexes going nowhere, simply because all expected another 10-20% up year. Big move year will be saved for later.

THE BIGGEST LEGITIMATE INSIDER OF THE WORLD

I have been quiet for a while and traffic to the blog is just from search bots. As a coincidence, we are investing into a startup producing web robots. I (kind of) just want to write to myself that I have no intention to close this blog.

The first half of 2014 was not kind to portfolio and it is mainly my mistake in position concentration of option-like trades (they were not investments), which should be a fraction of portfolio and I confused feeling and past luck in similar situations to skill and knowledge. I let positions rise and did not liquidate in time, so since options expired worthless, portfolio is down double digits. Think of RSH, UNTK…

All these portfolio hits and my general busyness and lack of time made me rethink my current investments tactics. I have to admit that head is quite messy. Market is high and tempting to remove hedges. At least shorting small caps was a somewhat right insight. Well, I keep reminding myself that there is a price for cherry consensus and if everything would look right, there would be no upside left.

Thinking about general market perceptions is a fruitless thing, too. Who in his right mind can measure it? Do people are bearish too much or enough or not enough for the market to keep on climbing the wall of worry? Low interest rates just do not look right to me. Muddle through and new normal were very precise descriptions and predictions at their origination. At least, about the general background (I do not need even to search for evidence, it keeps coming like on a live news feed: Link).

So, who is this insider?

I am getting Daily Reckoning updates daily and sometimes read them, especially Chris Mayer and Bill Bonner. Chris is really good in giving tips to new interesting companies (whom we all tend to collect) and books, while Bill is a master of word and common sense. However, this time I read about insiders from a different author (Link).

I carry this insider idea in my head from early spring when Ukrainian situation was in its emotional Maidan stage. Such events cause stock fluctuations and Russian political decision makers do not have to report to SEC. It is trivial to make a billion dollars with a simple press release. It is redistribution of wealth in Russia when rich will get richer. But only for those who are close to the man.

It is September now and the idea does not seam so convincing anymore. The man has proven to be unpredictable and it is unclear what are his real motives, if any. Gazprom is a huge arbitrage story where a company with such proven reserves would cost probably 100x more if situated in a stable democratic country. Everything has a price. You can see my thought flow and here is the chart. The thing has started to brew between January and March.

2013 END NOTES

2013 was fast as probably each year when you get older and especially when you have small kids.

It was a mixed bag for me - stock picking was almost 1.5x better than market but excessive hedge position, obviously, materially lowered the returns. I cannot complain – mid teens with low downside risk is quite good (longs were covered with 1.5x index shorts for most of the year). I would settle for 10% pa with limited risk given the elevated valuations because of high margins and multiples.

As I wrote before, this year I have spent little time on my portfolio. Probably, it was in the spirit of Charlie Munger (documented by Value Investing World): “We use a lot of experience and do it [investment returns] in our heads. We don’t like complexity and we distrust other systems and think it many times leads to false confidence. The harder you work, the more confidence you get. But you may be working hard on something that is false. We’re so afraid of that process so we don’t do it.” Devil is in the details and footnotes but more and more I notice that the first hour of reading gives 80% of thesis. The most important is if I can build a constructive opposite thesis – if I feel that something was overdone with price movement, I act. When I see that insiders are on my side, position gets bigger.

Almost all returns came from 2 boring cellular telcos. No moat, no profit (almost no). Value investors were skeptical. However, in such cases, holding period is not forever and IRRs are quite good. I hope (a very important word) that UNTK and EZPW will be similar.

Macro is another topic hated by value investors. It is an interesting time when long-term interest rates are going up together with homebuilders. Mr. Market is saying that higher interest rates will not affect the recovering housing market.  The money printing was reduced by ~10% and its annualized run rate now totals ~6% of US GDP, while interest rates went up 40-80%. That was a price discovery of roughly 7 months, which will continue.

TNX is 10Y yield, TYX is 30Y yield and XHB - homebuilders.

Many many investors think like me; therefore, it is not that contrarian and quite painful at the same time while it should be painful when alone. They think and act with hedging their portfolios and keep on fighting the last war. Understandably, perma-bears continue to capitulate. Hugh Hendry did that in kind of a funny way. He thinks it will get much much worse but it will get better before that, which is worth a try to gamble. Those who were unhedged are definitely winning, so far. WEB is among them but he is in his own long-term game (he is not exiting the market before crash like the most intend to do). Correct me if I am wrong but the last three horsemen standing are John Hussman, Gary Shilling and Hoisington. Still await for G. Shilling's 2014 outlook, which should come in the first weeks of January. It should be an interesting read because he ended his 2013 mid year views: “So here’s my “risk-off” quartet: short stocks and commodities, long the dollar and Treasuries.” So far, so bad…

I will speculate that surprisingly the world cannot withstand a higher long term interest rates and a complete stop to QE would not anyhow influence rates (I am talking about longer term as in a short term market would correct and people would fly to safety).

This year I started to practice a basket of “option” stocks (stocks, which are priced like options, usually close to $1). I will see if my stock picking instincts are worth a dime as so far the score is 0:2 (thanks to PNCL and GAXC; long DM and ABM.L). However, mathematically, I am sure I should continue. I will decide after 10 or so attempts and positions should be closer to 0.5% (now larger) for now. On the positive note, such things absorb natural inclination towards activity and gamble - modern man needs variety and to have at least some fun. Discipline is boring and painful.

After writing this, I got a little better regarding my short XHB position (hurting in the last few weeks). It is painful but feels like a right thing to do given another interest rates run up attempt, which I believe (a very important word) to be another fake. I should at least reduce it at $28, though. I am afraid for pent up demand and normal household formation, does not matter how slow it is. Something similar to what is going on with autos.

I am intrigued about NLY. LOJN is coming back to a trade-able range.

A few reminders:

> Next crash will come from something not known or too obvious.

> General trend of the market is up - roughly 3/4 of the time. White men will do everything to preserve status quo and inflation is the key element of this. 

> The world has not deleveraged, yet (it is beautiful but takes very long or another 3-6 years, remember EU bank leverage ratios…).

It is getting too long, so Happy New Year!

CONFESSION ABOUT LEAP

I noticed a worrisome and clearly morbid (but easily explainable and understandable) pattern in my head - after big gains and significant victories I tend to check account more often and I want to brag. This time there is no exception. I would like to believe and promise that once I will confess a big loss, in detail.

2013 just clocked the first half and 4 of my ~10 long holdings have been taken out. In a similar settings, 2010 brought me also 4 take-outs but this year has 6 months to go.

The last one came in a spectacular fashion. +100% on the takeout day and +150% in the last month. It was not an easy one because I almost sold it 2 month ago but decided to wait for long-term gain and while waiting it dropped 15%. In the time of waiting, another holding was taken out, price was low and urgency subsided. It is enigma, why I did not add :)

It was a difficult one because the multiple was high and because the leverage was high, too. Because what a guy in the other side of the world may know about intricacies of the US wireless telcos and smart people were thinking that prepaid niche is a poor business without competitive advantages. It turned out that prepaid were and are good quality assets comprising not only of multiples but also of spectrum, subscriber base (market share), and attractive cost structures. I am speaking about LEAP (and PCS).

To summarize the 2013 take-outs:

PCS – 425 days | 140% IRR

DELL – 270 days | 21% IRR (went down 25% before that)

MBND 430 days | 34% IRR (went down 30% before that)

LEAP 440 days | 155%

Interestingly, I stepped twice into the PCS river – in 2010/11, 425 days brought me 150% IRR.

Finally, last 12 month I spent only 1-2 hours per week working on my investing account. What could I do if it were a full time job? I am afraid, it could also be the opposite... Happy hunting.

RANDOM MUSSINGS (iii)

It seems to me that today everyone is a trend follower.  In 2009, everyone was macro economist. And both without apparent reason. It is clear today that the latter was wrong. At least, so far. I think that majority of the first will be trapped, too. Buffett is talking his book and eternal perspective and obviously he is right, so those who can afford to follow his advise, should definitely do that.  The rest at least has to be hedged.

I liked (let's call it) the battle of John Hussman and the Brooklyn Investor on the profit margins (a few additional dimensions on the subject - link). Frankly, after reading the Brooklyn Investor post I became hesitant, which means it is a must read. John seems like a strong statistician to me but as someone said owls are not what they seem.. Eternal perspective assumes that it is unclear what people will think when profit margins shrink, which is inevitable. In other words, multiple is uncertain. I still tend to lean towards a bias against high margins, which is now happening at the same time with a high multiple.

Graham with 50% in cash (link) is thinking in the same direction but instead of cash my hedge is a more aggressive bet (short of indexes).

A brief and eclectic stock update: INFU looks interesting below $1.40 (for a brief moment). Gazprom below $8.00, too. Gas reserves cannot cost 80x cheaper than at CHK for a long. However, Russian element brings some shiver in me. Umom Rasiju neponiatj (link - loose translation: you can't fathom Russia with mind). I do not have positions in both, yet. Of my holdings, LOJN looks cheap, trading almost at cash.

DELTA UPSET PINNACLE AIRLINES SHAREHOLDERS

It is about the right time to call the finale of the Pinnacle Airlines bankruptcy.

Delta Airlines, an iconic American brand, did not bother with shareholders of its subcontractor and took over a profitable and solvent company. What is interesting it took it over FREE OF CHARGE (yes, it provided financing, blah blah blah, and got hundreds for a few tens of millions).


Evidently, Delta follows a very strong set of guidelines as summarized in the Code of Ethics and Business Conduct:

Fair Dealing. Directors shall oversee fair dealing by employees, officers and directors with the Company's customers, suppliers, competitors and employees. "Fair dealing" means the avoidance of unfair advantage through manipulation, concealment, abuse of privileged information, misrepresentation of material facts, or any other unfair dealing practice. This Code provision will have no effect on existing legal rights and obligations of the Company and its employees, including "at will" employment arrangements.

As a shareholder, I would prefer a liquidation (without a credible attempt it was impossible to extract any shareholder value) and potentially a meaningful recovery of some shareholder money but a "greater good for society" argument in combination with questionable action of a judge (can he read the balance sheet?) and lack of shareholder coordination and financial resources to take the litigation risk negated this opportunity. What is greater good for society, though, a properly functioning and just civilization or preserved jobs in the hands of vulture iconic brands?

As written here: 

If Pinnacle were to liquidate, Delta wouldn’t have many options for regional jet service, putting the bargaining power in the regional airlines’ corner. Without Pinnacle, Delta’s options would be limited to Skywest Inc. and other smaller regional providers.

I forgot to mention the leading role of management, unwilling and incompetent to extract any value in such a strong bargaining situation for those who created them jobs. But they did really well for their new employer.

Here are the heroes: Board of Directors

Donald J. Breeding Chairman

Susan MacGregor Coughlin Director

Ian Massey Director

James E. McGehee Jr. Director

Thomas S. Schreier Director

R. Philip Shannon Director

Alfred T. Spain Director

Nicholas R. Tomassetti Director

John Spanjers Director

What are the lesson here? Anything is possible, anywhere. Even in Russia.

Debt layer of financial structure is much safer and considerably less prone for a binary outcome in similar situations.