A time to reflect

My four plus month hiatus from blogging has been a time of reflection. Yes, I could have continued to focus on the micro aspect of investing (stock selection, if you must) following some kind of modified Graham discipline. And, yes, in time, I’m sure this kind of approach would have produced respectable investment results. Instead I’ve been reflecting on the overall equity market and why my portfolio has underperformed the S&P 500 for the past 3 years, possible causes and possible solutions. My conclusion regarding the latter, perhaps delusional, is that my underperformance is structural in nature, due in large part to the fact that we are in the middle of an artificially protracted cycle, a bull market that is being kept alive by a fiscal respirator. I am hoping that during the waning parts of the cycle my portfolio will finally pull its weight. What do I mean by the ‘artificially protracted’ cycle? Consider the US equity market. Over time it tends to move gradually upward in waves, with troughs and peaks along the way. The current wave has been unusually long; the market has been trending upwards without much backtracking since March 2009, over 6 years, first rebounding from the liquidity panic and earnings compression of 2008/2009 then levitating further, fueled by interest rates artificially depressed through Quantitative Easing. And the effects of QE have certainly been more P/E expansion than revenue growth! Nothing new here. I think most market observers would agree. The question is, can multiple expansion continue? I think not, at least not in the long run. Again, I think most market observers would agree. Yet strangely, the equity markets continue climbing higher. I can only ascribe this to market participants’ fear of missing yet more P/E expansion, addicted as they have bec0me to valuation inflation. In short, I think the market is where it is right now because of GREED! And we know what a powerful force that can be even in the face of hard facts. Greed renders us delusional! That’s where I think we are right now, in the delusional phase. A recent example from another ‘market’ might help to put today’s equity markets in perspective. Remember last year at this time when oil was hovering around $100 a barrel? Then suddenly the price began to drop? It started slowly, then continued dropping and then dropped further! Now its bumping around the $50-$60 mark and who knows whether this is the bottom. Given the benefit of retrospect everybody seems to agree this price drop was inevitable, brought on by oversupply from additional shale oil production. But the shale oil revolution began well over 5 years ago, and we all had a pretty good idea as early as a couple of years ago what the impact was going to be. So why the big drop in oil prices only last year? I think it was because nobody WANTED the price of oil to drop, so it didn’t….. until the storage tanks were full, until traders began hiring tankers to just sit offshore and hold the surplus oil until prices began rising, etc. So the price stayed high… until it didn’t, then it fell hard and fast! I think that’s where we are with the stock market now. Greed and inertia keep most investors in the market and keep valuations high … and it will stay like this until the market starts going down. Then all hell will break loose!

Enough prognosticating! I don’t know when the market will begin its descent, though I know it will eventually (but maybe I’ll be dead by then!). For me, as the averages creep higher and higher I feel like I have to hold more and more cash, or at least move into investments that are less market correlated, special situations and such.

When last I posted I had just sold 1/4 of my largest position, AIG, and reinvested the proceeds into a number of special situations; three spin offs (COVS, RYAM and CVEO) a net-net (EPAX), two liquidations (FUR and GYRO) and a classic Fisher investment, (ZINC). The results have been less than spectacular. Actually, for the 1st quarter the results were horrendous, but recently there has been a bit of a turnaround in the shares of these companies, although overall they are still lagging the market. I did make a few changes to my portfolio during the first quarter that I didn’t note here (adding to my ZINC and GYRO positions, opening a new position in BFCF and closing out my Liberty Media positions). However, these were all part of the strategy to move funds into special situation investments, away from positions closely correlated with market moves into more market-uncorrelated positions. I have just now sold another half of my remaining AIG position, which I plan to partially reinvest in a liquidation situation (that will remain nameless until I have made the investment).

I look forward to posting more regularly about my positions in the near future.