Ramblings of a Portfolio Manager

Street Signs

Our apologies to the folks at CNBC for borrowing the name of their daily segment as our tag- line. It just seems to fit so well with the events that transpired last week. We claim no affiliation, imagined or real, with CNBC or its affiliates but if they wish to sue they know how to find us.

We were going to start this piece with “It was a dark and stormy week…” but that seemed a little cliché and a lot Bram Stoker. Instead, we thought we would share some of our observations, which we believe signal that pessimism has reached a fever pitch and, therefore, perhaps a market bottom has been reached. So here, in no particular order but with some subjective commentary, are the top 10 contrary signs we witnessed from Wall Street last week:

1. CNBC ran a weekly segment entitled “anything but stocks.” It covered potential asset classes from Gold, to fine art, to classic cars. The message: stocks are out, collectibles are in. By the way, the illiquidity, the bid/ask spread, and the unregulated fee/commission structure on these “assets” would make a congressman cringe, however, we didn’t hear any indignant Senators grilling Sotheby’s for selling a Picasso with a 20% seller’s discount and a 10% buyer’s premium, plus a listing fee, or for knowingly shorting a ’71 Hemi ‘Cuda Convertible (35% Bondo) for $2mm to a supposedly “sophisticated” buyer bidding from the complimentary bar.

2. More Greek rioting was splashed across the TV (minus the goat, which we are now sure became Gyros for the rioters). The effect on the capital markets was much, much more muted that the first round. Obviously, the Market is becoming desensitized to such media spectacles.

3. Nouriel Roubini was dragged out, after a year of hibernation, to proclaim that stocks could drop another 20%. Why? Because “they’ve gone up so much.” Now there’s some sophisticated analysis for you. The “broken clock” method always seems to work at least once in a lifetime.

4. Meredith Whitney was also put on screen to admonish us “not to touch any financials.” We’re not sure how Multinational Money Center Banks exposed to EU debt share the same risk profiles as regional banks, private mortgage insurers or consumer finance companies. But Meredith had the right call in 2008 and if the broken clock approach worked for Nouriel, why not also for Meredith. Besides, she is a lot prettier.

5. The volatility index, or VIX, spiked upward around to around 45. For the VIX to stay there would mean that the market’s expectation is for very large changes over an extended time frame. In the 15 years leading up to the VIX’s creation in 2003, price changes of 5% or more in either direction occurred only eight times. It is also interesting that the VIX behaved similarly in 1997, hitting a high of 48.64 during the height of the Asian Contagion. Thus far into the European Contagion, the VIX has hit a high of 45.79.

6. Gary Kaminsky, of CNBC’s fast money, officially declared “the death of buy and hold.” He, and many others, said the same back in March, 2009.

7. Jim Cramer is back to his “buy the accidental high yielders” strategy. He pursued this philosophy all the way to the bottom in March and abandoned it only near the top, when the yields were no longer as high. While that might make sense, he never issued a “sell” recommendation so most of his followers probably still hold the stocks he recommended when they were at high yields; while the yields are now lower, investors are still earning the same (if not higher) dividend stream. Unfortunately, they missed the rapid appreciation of some of the lower yield growth stocks on the way up. Chances are they are smart enough not do so again.

8. At least one prominent analyst admonished eschewing stocks while there was “oil in the water and blood on the streets, which is what we have now.” Warren Buffett tells us those are the best times to start buying. We like Warren.

9. The annual SkyBridge Alternatives (SALT) conference of the “smartest guys on Wall Street” took place in Las Vegas amid heavy media coverage. Mass “group think” ensued, as it often does in these conferences (which is why we avoid them), and fed upon itself, with the emergent consensus being that the world was coming to an end and we all must “de-risk.” That is exactly what all the smartest guys did publicly Thursday on CNBC, as they picked up the phones and called in their sell orders. We note that the heaviest selling and biggest drop in the markets came on that day.

10. A public opinion poll showed that Goldman Sachs and Wall Street enjoy a lower approval rating than Congress. Perhaps Bernie Madoff will replace Lloyd Blankfein and Ted Bundy will replace Nancy Pelosi (the latter certainly being a trade up).

11. OK, we said 10 but we couldn’t resist this one. London pawn shops and bullion dealers reported that they are out of gold to sell. ebay is listing gold coins and ingots at 15-20% premiums over spot prices of the metal (by the way, that’s better than the commission those Good Fellas on TV will charge you) and an ingenious entrepreneur just installed several ATM machines to dispense gold ingots instead of currency. We’re not sure how to buy a Big Mac and Fries with an ingot but when we do we’ll be sure to let you know.

We think you get where we are going with all this. Sentiment is very bad, stocks are down and no one is paying attention to fundamentals, which happen to be good. More often than not, this signals a good time to buy stocks and while it is almost impossible to call the bottom, certainly we must be closer to it now than we were three weeks ago.

Frequent bear and always smart guy Doug Kass turned positive on stocks on Friday. Said Mr. Kass,” The market has every reason to lose steam this afternoon, but it's hanging in there. I think that the action today is bullish and we might have seen a bottom for some time to come.” Doug was right in calling the bottom on March 6^th, 2009 but wrong by calling a top at S&P 1020. If his recent track record is only 50%, why do we even bother mentioning him? Well, to start, he correctly called the mortgage crisis of 2008 back in ’07, well before anyone saw it coming, he declared Fannie Mae and Freddie Mac technically insolvent in 2008, enduring derision, and he correctly picked the stock market bottom in March 2009. Secondly, unlike the broken clocks, he is willing to change his opinion as the facts change and he is willing to admit when he was wrong. His picks now: retailers, private mortgage insurers and China. Coincidentally, that happens to be how our portfolio is positioned. Though it isn’t working well at this moment, we expect Kass to be correct and for significant outperformance to lie ahead.

Ramblings of a Portfolio Manager

Ramblings End of Week Update

We’re sure many clients are watching the capital markets with concern. We don’t believe things are anywhere near as bad as they were in September of 2008, however, market sentiment is almost as bad. Because we focus on small caps, our portfolio has been positioned in very US-centric companies, which should not be as directly sensitive to a slowdown in Europe or Asia as would large cap, global companies.

Our philosophy has always been to sell euphoria, buy panic. Right now we have a great confluence of negative events, from the debt crisis in Europe to the Financial Regulation Bill in Congress. The result has been that the fear indicators are reaching levels not seen since 2008. Most of this, we believe, is headline risk only and we are, therefore, taking advantage of the sell-off in select areas with a focus on low P/E, quality companies with strong balance sheets, in line with our long-term investment philosophy. We continue to see improving fundamentals in the US and Asia and look at this as a normal sell-off in a cyclical bull market. We are also putting our money where our mouths are and are investing more in the fund, believing that significant opportunities for appreciation lie ahead.

We encourage any investor with questions or concerns to feel free to call us at any time.

Rick and Chris

Ramblings of a Portfolio Manager

When the Tail Wags the Dog

2% of US GDP. That’s what exports to the entire European Union comprise of our nation’s annual output. Hardly seems worth the volatility that the market put us through last week. Of course, the prevailing fear is the “domino” or “cascade” effect of a weaker EU on the rest of the world and thus, ultimately, the US. We’ve seen this movie several times before. The premier, “Tarp I,” of course, was in September of 2008. The first sequel, “Oh God Obama!,” came in January through February of 2009. The third iteration, entitled “Double Dip,” debuted in July last year. Like all bad movies, the first was better than the sequels—and, as with most movies, it was the “real deal.” The others were just tarted up imposters. Now we have “Contagion IV. The Euro Story.” Is it worth seeing? We think not.

In our little book of investing, E stands for Earnings, not Europe. An excerpt from Ramblings, July 20th 2009:

Anyhow, all we are saying here is that this earnings season should actually turn out to be a good old fashioned one—some beats, some misses, some “in lines.” And that is what makes markets, produces opportunities on both the long and short sides and makes fundamentally-based active money management worth pursuing.

We feel the same way today. Right now the US markets are trading in more or less in direct correlation with the Euro, with exporters getting hit harder than domestically focused companies. We understand the psychology—a strong dollar makes our exporters less competitive vis-à-vis their European competitors and a weak Europe means reduced exports to that trading bloc. But things don’t just work that simply. First of all, as we point out, only 2% of our GDP is based on exports to Europe. Secondly, many of our exporters have no real European competition—think technology and pharmaceuticals. Thirdly, along with a stronger dollar, we have weaker oil (down 20% so far this month), which is like a tax cut for all companies, world wide. Finally, while a weak Euro does mean that European exports to the rest of the world are more competitive, it also means that Europe stands a chance of exporting its way out of an economic slowdown—in fact, UBS upgraded the EU for just that reason today.

We suggest investors turn off the TV and just watch the earnings reports and guidance from the US coming across the tape. It’s a better and more uplifting movie

Ramblings of a Portfolio Manager

Fat Fingers, Thinner Wallets.

It would have been comical had not the financial anguish been so great or the memories it evoked so painful. There, last Thursday, on the right side of the screen were hundreds of government employees expressing their anger and frustration in a childish temper tantrum at the dilemma that they themselves had caused. On the left side was the Dow, tick by tick, dropping with every Molotov, er Metaxa cocktail let fly. We’re talking, of course, about the Greek Government Union employees rioting at the austerity cuts mandated by the EU bailout package. The would-be comical part was the goat, seen in all the videos, running helter skelter amid the chaos. The not-so-comical part was the close analogy it drew to another scary media spectacle just 19 months earlier. There too, hundreds of childish government employees vented their feigned and hypocritical wrath at a situation that they also caused while the world watched the capital markets fall, tick by tick. That, of course, was the vote on the TARP bailout bill in Congress. Unfortunately, in that scenario the only goat (the “scape” kind) was Hank Paulson, who had to take the blame from grandstanding hypocritical Senators (e.g. Barney Frank) for a situation he certainly didn’t cause but was clearly using all his powers to avert. The Greek goat probably ended up as Souvlaki, roasted over the trash fires by hungry cops (we noted that all the donut shops had already been looted by the other Unions). The American goat, thanks to our more “mature” society, was labeled “damaged goods” and got to write a book that helped augment his stack of T-Bills. It’s a great country.

Amid the televised media spectacle investor panic sent the Dow down almost 1000 points intraday before recovering almost 700 of those points. We’re not qualified to even speculate upon the reasons for the resultant gut-wrenching move, which occurred in just 15 minutes, so we’re not going there…although there is a “grassy knoll” theorist around here who is convinced it was all the work of cyber-terrorists. We’re going to give him some time off to spend with a certain Police Chief we recently had to let go in part due to his conviction that the local nut case who was blowing up porta-potties was in truth an Al Quaeda cell practicing for an attack on the Empire State Building. On second thought, that nut case was released just last week from the hoosegow…hmmmm.

Instead of opining on last week events, we thought we’d give a little test to see who was paying attention. Ready? Here are some headlines from last week. Music please! One of these things is not like the other. One of these things just doesn’t belong. Can you tell which thing is not like the others by the time I sell all my longs?

a. EU Raises 2010 GDP Forecast
b. China’s October Manufacturing Grows at Faster Pace
c. Oct. ISM Factory Index Surges to 55.7%
d. World Equity Markets Lose More Value Than the Combined GDP of the PIGS
e. U.K. October House Prices Gain for Third Month
f. UK Manufacturing PMI at Two-Year High
g. US Employers add 290,000 jobs, Twice the Consensus
h. Australia Increases Benchmark Interest Rate to 3.5%
i. Barrons says “here's a chance to shop for stocks.”

Time’s up! The astute among you noticed immediately that this was a trick question as we all know that Barron’s wound NEVER publish a bullish article on stocks. Right? Wong! Actually, they did. May 8th: “Try not to get rattled by the market rout. Instead, here's a chance to shop for stocks.” Go figure. So the correct answer is “d.” Yes, world equity markets did indeed erase more in value than the entire combined GDP of the PIGS (approximately $4Trillion) in just 4 days last week, which flies in the face of all the positive (in some cases too strong) economic data from around the world. Keeping it all in a Fred Rogers framework: “Over reaction. Can you say that?”

OK, for those of you who missed it, here’s another, easier little test:

Question: Which country is the largest exporter to the EU?

a. United States
b. China
c. Japan
d. Australia
e. Germany
f. The EU

Also a trick question. Yes, the EU is the largest exporter of goods to itself. However, within the EU, Germany is the largest sovereign country to export to the EU and the second largest exporter in the world, after China. The US comes in third in world rankings. Why does this matter? Well, with all the handwringing over the world impact of a European slowdown, one should consider who will be affected first. China, as we all know, is in the midst of a tightening phase due to excessive economic strength. Germany was about to go there before the Greek mess hit and the US is still contemplating tightening after already beginning the liquidity withdrawal. These countries, if beset by export declines due to EU weakness can turn their monetary policies on a dime, as they did in 2008. That, in our opinion, would start the liquidity cycle all over again, driving up stock prices, among other effects. So, while we realize that the story isn’t just Greece but the so-called domino effect across Europe and that all the positive data coming out of countries right now is “rear view mirror” information, we also understand that there is a fair amount of firepower left in the largest economic powers to prevent another financial crisis, which is what the markets fear is happening now.

Oh Oh! As Rosanne Rosanadanna would say, “never mind!”

Timing is everything and as we write this we see that the EU Ministers have approved a $962 billion fund to bolster the Euro and to stave off further debt-crises in member countries. In one fell swoop, this move takes the PIGS off the table. Along with the loan package the European Central Bank will initiate their version of “quantitative easing,” something that last week its president, Jean-Claude Trichet, said the central bank didn't even contemplate. The ECB will go into the secondary market to buy euro-zone national bonds and the Federal Reserve has re-activated swap lines so foreign institutions can get access to loans. It’s an unprecedented move from what here-to-now has been an agonizingly slow, almost constipated, European bureaucratic system. It’s also surprising show of cooperation among central banks. The markets seem to like it and as of this writing Dow futures are up over 400 points.

So as the CNBC junkies cover their shorts in the Euro, let us praise the EU Ministers, mourn the goat and remember that you heard of this first on Ramblings: Special Edition, last Thursday.

Ramblings of a Portfolio Manager

Greek for Dummies… and PIGS

With all the news surrounding the PIGS last week, particularly Greece, we thought it would be helpful if we provided a little primer to help investors understand some of the more complex Hellenic financial terms flying around the airwaves. So here, in the language of Aeschylus, is the week in review:

hypokrites. n. Gk a stage actor, hence one who pretends to be what he is not. See also oraculum. v. L to plead. ME hypocrite: one who denounces derivatives as “financial weapons of mass destruction” prior to emerging as one of the largest investors in said weapons and criticizing the Government’s plan to regulate such.

amnestía. n. Gk oblivion. See also ME hypocrite. ME amnesia: a group that protests the “cost to taxpayers” of bailing out Wall Street, which paid the Government back in full plus interest, “forgetting” that its own constituency placed taxpayers in the same situation with GM, receiving ownership in the Company in return while being allowed to pay back those taxpayers with their own money ( i.e. TARP funds).

phone. n. Gk sound, voice. See also L senatus, council of elders. See also ME hypocrite. ME phoney: 1: someone who takes money from another and in return puts the donor through a public show trial to enhance the probability of re-election. 2: public criticism of an institution for “adding no value” by an individual who destroys value. See also slang doddism n. cognitive deterioration.

moros. n. Gk foolish, stupid. See also ME worthless. ME moron: 1: one who helps create a global Standard of being Poor. 2: a group or entity paid to opine on the financial health of another and who, having failed spectacularly, downgrades the debt rating of a sovereign entity in obvious financial distress, after the value of that entity’s bonds has already declined 38%, hoping no-one notices.

eirene. n. Gk oil. See also ME double standard, fr. Gk diploos + histanai, to cause to stand twice. ME oil: A value system under which an environmental disaster is never the fault of philosophically liberal politicians or government entities, even when they publicly support the conditions that created the disaster in the first place.

Next week, depending upon which of the PIGS makes the headlines, we will explore the romance languages.

Please call for this weeks highlighted stocks.