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.

INTERESTING FEELINGS

I have been silent for quite a long time. Do not have much to say, just to note that I remain bearish for no particular reason. It is probably nature of contrarian pretenders to think in the opposite direction than the majority.

Downtown Josh (I like his writings a lot) is pounding weekly how the tide is turning and the snowball starts rolling like a train. Even EU ongoing disaster and Chinese real estate bubble correction cannot even bump it. And nothing (known) in sight can change the situation. Josh probably wants to sound balanced and neutral but this how I feel after reading him.

I try to check my temper with John Hussman’s weekly musings. Last Monday, he once again produced the calm for me. Human beings really need to belong somewhere and to rationalize everything. In business cycles though it is crucial to synchronize ones expectations with the real pace of life.

All is not well but it is really painful to remain hedged. This pain gives me the feeling of rightness (check – do I have masochistic inclinations?). It is much much easier to go with the stream, like in March 2009 (meaning not to buy stocks at that time). There is huge assumption in the sky that economy is sustainable, the Fed will be able to stop printing and deficit will shrink; and who cares if this is not true…

Stocks are high and bonds are high. Are people taking profits? Is it smart to do that now? Most think that we will ride further up. Those who are afraid of bonds sell them and buy stocks but somebody is always on the other side of the trade. For some reason, somebody is doing the opposite: buying bond and selling stock. Or people earn money and send them to former owners of bonds and stocks, who hell knows what do with this cash. Really what matters is demand and supply – on both, general market and on the micro individual security level.

I am on the edge of initiating a significant position, 3x my normal position size, approaching 10% of net worth. It is a cable company which probably will enter reorganization and it’s debt now trades at ~2.5x EBITDA. I thought that writing about this will give me some courage, for it may be a long ride without daily quotes. In December, I almost bought it at 45, in two weeks it went up to 65 and now back to 50. YTM is >30% for the next 3 years (10% would be enough for me). What is not to like? Cable is an asset in bear or bull.

It is great to have a blog and confess to ones consciousness and others. Whoever that is.