On the oddness of this bull run

Markets near all-time highs, but consumer confidence at recessionary levels.
While corporate profits are at all time highs.
But as this Bernstein research piece notes, the bulk of this high earnings level is a result of (1) low interest payments due to the Fed keeping rates near zero and (2) low depreciation due to low capital investment.

Investec Value Fund 2012

As stated in a prior post about Value Investing, too rigid an approach can sometimes lead to problems in performance. Lets look at Investec Value Fund's performance in 2012 to understand how and why things go wrong. The fund had a negative 24% alpha versus the JSE All Share Index in 2012 (2.0% vs 26.7%). The top 10 holdings at the end of 2012 were:


1) Steinhoff Int'l Hldgs Ltd [+12%]
2) Gold Fields [-15%]
3) Anglo American Platinum Ltd [-20%]
4) Anglogold Ashanti Ltd [-30%]
5) Sappi Ltd [+24%]
6) Sasol Ltd [0%]
7) Kap Industrial Holdings Ltd [+13%]
8) Absa Group Ltd [+17%]
9) Sun International Ltd [+13%]
10) JD Group Ltd/south Africa [-7%]

Note that the entire fund is not fully invested in the South African stock market. Domestic Equities make up 68.2%,  International Equities 25.4% and Domestic Money Market 6.4%. Part of the funds negative alpha may have materialized from the allocation to International Equities. The S&P 500 returned (1277 >1426 = 11.66%) and MSCI World (1186 >1338.50 = 12.85%). Given that the rand only depreciated by 5% against the dollar in 2012 we can see how having exposure to offshore equities affected performance.

Let's look at the year end portfolio against the top 10 shares in the Top 40:

1) BHP Billiton [+17%]
2) SAB Miller [+50%]
3) Anglo American PLC [-17%]
4) Richemont [+69%]
5) MTN [+38%]
6) Sasol [0%]
7) Naspers [+48%]
8) Standard Bank [+16%]
9) Firstrand [+50%]
10) Old Mutual [+55%]

Comparing the Investec fund to the Top40, we notice a few things:
1) Preference for foreign, rand weakness. SA Value investors perennial 'short' bias to SA - get hurt in periods of SA outperformance
2) Preference for rule-based cheapness (low PEs) rather than quality. This could lead to value traps.
3) Crisis exposure (gold, in two large holdings).
4) Preference for Book Value based cheapness over near-term earnings (platinum holdings).


References:
http://www.investecassetmanagement.com/south-africa/upload/pdf/SA_Fact_Sheet_Value_Fund.pdf
http://www.investecassetmanagement.com/namibia/upload/pdf/SA_Inv_Comm_Value_Fund.pdf

Cost to GDP of the 2013 Fiscal Cliff Deal

Here is what I've come across so far in terms of what the deal will do to US growth in 2013:

Feroli (JPM) says growth will be hit by 1%
Rosenberg (Gluskin Sheff) thinks it will be 1.5%
Goldman Sachs says 1.3%
Kit Juckes (SocGen) oddly sees the deal adding 0.5% to GDP. Perhaps this is from a baseline of a fiscal cliff occurring.

In summary, US GDP should struggle in 2013, coming in around 1.0% - 1.5%.

UPDATE: Chicago Fed Charles Evans sees US growth at 2.5% for 2013 

Value Investing in Fast Changing Environments.... (an introduction)

There has been a thought I've been mulling over the past few years with regard to the calls I've made during my investment career, and the performance subsequent to the formation of these views. Why did I call some companies so badly? And why did I miss some stonking ten-baggers? It's easy to just fall back on "information-set was incomplete" as a convenient excuse, but I think some reflection wouldn't be amiss.

Let's start with the assumption that I was always a value investor. That is, apart from what my tactical trading opinions may have been at the time, I believed that the stock had an intrinsic value that could be estimated within an error range of approximately 30%. The reason for the wide range would be lack of non-public information, acts of god, macroeconomic events etc. However, when I see a stock become a ten-bagger, and it doesn't seem at the point in time in the future that it is considerably overvalued, I ask myself how could I have been SO wrong! What analytical flaws plague me?

I have since hypothesized that my problem is that I have been schooled in a value investors school that is very static. I think it suffers this problem due to two main reasons: most value investor analytical approaches use backward looking data, such as formulas, charts, reversions to the mean, etc. Secondly, the investment process in many value investment houses were primarily formulated in environments that were slow moving, mature, declining in growth rate. Such as mature Europe and America.

I shall attempt to explain why these two factors pose problems for value investing in fast changing environments. Firstly, being backward looking, mean reverting etc will totally ignore structural changes. In a mature environment, such structural changes which have such massive impact on a stock do not happen as frequently. Furthermore, fast changing markets tend to be younger markets. Hence the financial time-series data is shorter, resulting in judgements based on past data less meaningful. On the second point, investment process being cultivated in slow moving markets. The problem with this is that there is a widely held belief that a stock's intrinsic value should be well known after doing thorough research, and unless anything particularly unforeseen occurs, the stock's intrinsic value should appreciate at it's cost of capital from the time that the initial valuation is conducted. This creates two problems. The habit of not revisiting stock valuations as frequently as one should, resulting in outdated and therefore incorrect valuations. And far more worrisome, creating the culture that looks down on those who have frequent valuations which veer violently over time, as this apparently suggests that the analyst doesn't have a firm grip on value and is being swayed by the market and sentiment.

Paradoxically, this creates  a culture sometimes of value investors applauding those who have valuations far from intrinsic value. Even though a 'value' analyst may have had his number 80% below NAV, of a company, which is clearly incorrect if the book consists of healthy assets, it is seen favourably that he stuck with his valuation through thick and thin. This indicates good process, having conviction in his valuation.

But sometimes, realities do change. And in fast changing economies, faster than one would think. The clear example would be how Nokia and Blackberry, the former at one stage being the largest phone manufacturer in the world, the latter the largest smartphone manufacturer, so quickly fell from grace.

So what is the correct process to adopt? I propose that value investing should move away from the shackles of being the step-child of bond investing, discounting future dividends into perpetuity, and align itself more closely with the real options approach.

Companies, and the economy, exist in a tree structure, such as in the real options approach. At each time step, the states have changed. Valuation for the prior period was conducted by averaging out the future states that could have occurred, such as Expected Value in statistics. However, upon progressing to the next time step in the tree structure, the forward-looking probability structure has changed, and certain branches which initially formed part of the averaging calculation have now been eliminated, and therefore a whole new valuation needs to be done with this new statistical set. This explains why the 'unwinding of discount' attitude which is prevalent amongst value investors is unhelpful.

Essentially, what I'm calling for is the suggestion that a value analyst should focus on doing a total reevaluation of all the stocks in his portfolio during each 'time-step'. This should perhaps be every 6 or 12 months. And it's okay if the value changes wildly after a single time-step. Irreversible things happen to companies in short periods of time, both good and bad.

A value investor who is stale isn't really a value investor at all. 

IK of FTAV on Fed operations

NY Fed has just slipped something out

It’s very exciting. One of my predictions was that rather than do QE

They would either fiddle with IOER or increase reverse repos

and now..

http://www.newyorkfed.org/markets/opolicy/operating_policy_110812.html

Going forward, the Federal Reserve plans to conduct a series of small-scale reverse repurchase transactions about every two months, which will bring the frequency of these operational exercises in line with that of the Term Deposit Facility exercises.

the statement has a certain “move on, nothing to see here”

THIS is HUGELY important IMO

Because what were we conditioned to think about reverse repos?

That they were an exit policy… a move towards tightening

Yet.. note what the Fed says:

"Like the earlier operational readiness exercises, this work is a matter of prudent advance planning by the Federal Reserve. The operations have been designed to have no material impact on the availability of reserves or on market rates. Specifically, the aggregate amount of outstanding reverse repo transactions will be very small relative to the level of excess reserves, and the transactions will be conducted at current market rates. These operations do not represent a change in the stance of monetary policy, and no inference should be drawn about the timing of any change in the stance of monetary policy in the future."

“The operations have been designed to have no material impact on the availability of reserves or on market rates”

These are reverse repos that are not ANYTHING to do with tightening

JM

So therefore… it’s merely a funding issue?

IK

No not at all JM

I fear… this is because they’ve come to a brick wall

Market wanted QE

But what market misunderstands, is that at a certain point in a liquidity trap QE becomes the exact opposite of adding liquidity

It arguably becomes deflationary

because it kills the number of Treasuries in the market

If the liquidity preference for Treasuries is such that the market doesn’t mind overpaying vs face value…

You get a very similar situation you had during the great depression

And with fewer Ts in the market, that becomes a risk

Especially if the “floor mechanism”

which the fed has instituted, has been compromised

By the FDIC fee

And money markets funds are finding it hard to not break a buck, and custodians are charging for large deposits

In which case… the best thing the Fed can do, is start reverse repos

Especially to money market funds, who are tight tight tigh on bills

Does that make sense?

It’s basically to stop treasuries becoming a bit of a giffen good

I see “bit of” because giffens re inferior goods… but the point is the same

Usual supply demand law doesn’t apply. Price goes up, people still want to buy…capital is destroyed.. we start the deflationary chain

Negative rates in the US have to be avoided if there is indeed a liquidity trap

Unlike switzerland which has arguably a good amount of creditworthy individuals to intermediate funds to

In a system where banks won’t lend cause they don’t think they’ll get their capital back..

Negative interest rates will not necessarily encourage banks to lend

Anyway this is definitely Bernanke’s thinking, if you read his magnum opus

@milky – that’s the point, they can’t inflate

They are stuck in a liquidity trap

Like Japan

They would love to inflate

which is why they don’t intervene when people go around suggesting QE is money printing. If market psychology thinks QE=money printing

That’s just fine

But QE isn’t really money printing at all

not in the sense that everyone thinks. It’s an asset swap. (Richard Koo makes similar point)

designed to help liquidity

Helicopter Ben is a fallacy

He’s expanding the Fed’s balance sheet, and base money

But wider monetary measures are not budging

In deflation the debt burden gets bigger

and in a highly leveraged society

that’s just awful

@Icarus.. expansion of balance sheet yes. But that’s not tantamount to money printing.

@Icarus .. if you research the Fed’s actions in the Great Depression

They also hit the socalled “printing presses”

Exactly the same way as now

If QE was money printing, how come it didn’t help back then?

The only difference really between what the Fed did then and now (from what i’ve researched…) is that they didn’t impose Interest on excess reserves

And there was the gold factor to consider

@schöneblume – since when is the m2 growth?

I had a chart of m2

Right — but when was the sharpest increase?

hang on cause it really makes the point

http://av.r.ftdata.co.uk/files/2011/08/M2.jpg

there’s the M2 chart

2nd biggest US M2 jump in history in 6 weeks to Aug 1…

led by a 26.1%, $147.4bln jump in demand deposits and a 4.8%,

$222.2bn rise in savings depos at banks….. and funded by

a $140bln, 7.9% fall in institutional money market funds

From Sean Corrigan

So the “money printing” only became a problem very very recently

Only on a M2 basis

That means money market funds started investing in cash rather than in bills

And that’s only because they didn’t want to lose money

Or break the buck

But since then the market moved… to contain that issue. BNYM said it would charge for deposits over $50m

What will MMs do

They’re stuck. They lose money on deposits.. or on bills

So the M2 boom is only temporary. And goes no further than MMs.

Which is why.. Fed sees it as a problem with the MMs. They have to have to be able to invest in bills

and Fed is responding by increasing its reverse repos

The MMs have MORE than enough cash on their hands…

Double Dip

Denmark now enters a recession, following Portugal and Japan. Yet not much coverage of this economic double dip.

Global Supply Chains

One of the effects of the recent unfortunate earthquake in Japan has been the disruption of automotive supply chains. For example, one facility, Renesas's Naka factory, has 20% of global auto production relying upon its output. As we move towards a more globalized world, should we have higher risk premiums to defend ourselves against such concentration of risk?