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!

INVESTING UPDATE (i)

This year I am trading a lot. Made 9 trades already (compared to 12 in the entire 2010 and 14 in 2009). Sold big 2011 winners (CRYP, INSW, TLB) and shorted XHL and IWO (R2000 Growth) last week to the tune of 40% of portfolio equity (in addition to 35% existing short ETFs).

With S&P @ 1,400, the market climbing a wall of worry (China, Europe, Japan, USA, oil/Iran) and profit margins at all time highs mainly fed by government deficits (James Montier of GMO – link), in support to mean reversion concept I decided to initiate a more aggressive hedging stance. It was painful to do, which gives a feeling of rightness.

I followed RSH for a long time and initiated 5% long position @ $7.06. The stock traded at this level back in 1982, 1984, 1990-1992, and 2009. Radio Shack will have to reinvent itself (between formats, hardware & service providers) once again but long term rear view mirror provides comfort for an investor with 2-3 year horizon. A vast convenience network must have higher value than 0.15x sales. The stock now is priced as if business would not generate any economic value in the future (priced at less than tangible equity) but it is making money. I would be happy if RSH delivers $0.5-0.6 EPS in 2012 (lower than consensus for what it is worth). In the meantime, it is paying 7.5% dividend and I plan to average down if RSH drops the dividend.

Other outstanding company longs are: CSC, CSCO, LOJN, IPAS, BRK.B, and GCA.

2011 Overview

2011 was exceptionally good generating 23% returns. I had small leverage, so equity returns were even larger. This was achieved despite having almost 50% of portfolio in SH and RWM (inverse S&P and Russell 2000 ETFs), which cost me dearly because of lack of diligence. A few spikes in intra year volatility knocked correlations down, which resulted in almost the same annual return for Russell 2000 and its supposedly inverse ETF of -5%. SPY and SH relationship was even worse – 0% (S&P) vs. -8% (SH). There are no limitations for human folly.

Fortunately, 4 holdings (KSP, INSW, CRYP, and TLB) were taken out during 2011 for quite a nice premium. Well, TLB is not acquired yet but it got a strong offer, which lead to my exit. At the end of 2010, I had only 6 company stocks (PCS and GCA in addition), so impact of takeouts was meaningful. Additionally, at the peak of EUR/USD in the end of April, I initiated 5% position in EUR/USD put option @ 1.45 maturing in January 2013 (via FXE), which generated 85% return in 2011. I plan to sell it on anniversary, and initiate a new 2-year option position.

Track Record

This spring is the 4^th anniversary of my active practicing of value investing, which started after a few years of extensive theoretical preparation. I am all my conscious life in finance but this does not mean anything because real things started only around 2005.

So, how am I doing? 22 positions initiated in total, 4 closed losses (incl. 1 “hedge”), 3 open hedge losses, 1 open loss (RSH), 13.5% IRR (xIRR Google Finance function), 50% portfolio return, and average weighted xIRR of 32%.

Seems like quite a lot of things happened since the spring of 2008.