Your market call?

[Cardboard]

Santayana,

 

That is actually a very interesting question and one that bugs me greatly. My "market call" question is actually tied to this question.

 

Intrinsic value is tied to many things including interest rates, growth rate of the economy, the type of valuations assigned to businesses, etc. It becomes a very wide range hence Buffett mentioning that he prefers to be vaguely correct than precisely wrong.

 

This bear market has given me an opportunity to buy businesses at such a discount to intrinsic value that there is simply no way that I did not have a large margin of safety. However, with the rally that we have had, and that seems poised to continue, we may reach a point where we hit intrinsic value for many stocks, but we don't realize it if we keep using yardsticks from the recent past. For example, is a P/E of 10 all you can hope for in the next 5 years for small caps? Is a slight discount to book value something reasonable to expect?

 

Considering that time is money, it is probably worth thinking about what valuations will tend to be going forward.

 

Cardboard

 

 

[niels12think]

• It's ok to buy at a price higher than value, because you can always sell to a price even higher (you plan to sell to a greater fool).
  
• It's ok to sell at a price lower than value, because you can always buy to a price even lower (you plan to buy from a greater fool).
  

 

Really, these statements seems to me to simply disregard value?

 

 

They are not the same! When you buy at a discount to IV, you have a margin of safety. You would do fine selling it a lower discount to IV. Say you buy at 50% discount to IV, you can choose to sell it when it is only at a 30% discount to IV and still do fine, but would not do as well as when you sell it close to IV.

 

When you buy at a premium to IV, there is no margin of safety. You are just hoping for a greater fool to show up.

 

Vinod

 

I'm not saying that you won't do fine selling at a lower discount to IV. But if you plan to load up again at a greater discount to IV, then you are in reality speculating to buy from a greater fool?

This is also true if you buy another issue immediately - indeed, in this case you believe your own estimate of IV is more accurate than the "greater fool".

Instead, why not opt for a greater margin of safety by selling (possibly short) an issue trading (much) higher than IV instead of selling the issue trading at a small discount to IV ?

Shouldn't this improve either your odds and/or your gains compared to selling issues below IV?

 

But we're moving further away from the point: isn't a market call in reality just a Mr. Market call, trying to estimate the odds for the behavior of Mr. Market?

 

Cheers

[Guest Broxburnboy]

I think it may be time to consider that perhaps the value investing paradigm is dead (at least until we reenter a period of global growth).

It may be that it only works in long term bull markets and is in reality a variation of the "rising tide floats all boats" effect.  By carefully picking

"boats" with more favourable metrics (value, margin of safety), the value investor trades dips in submarkets, hence beating the average.

Since the market topped in August of 2007, value portfolios have taken a huge hit, in many cases a much larger one that the indexes.

The way to prosper since that time has been by hedging, short selling and trading into rallies. It looks to me like that strategy will

continue to be effective for the foreseeable future.

Professional and experienced traders sell on strength, buy on weakness, sit on the sidelines in times of uncertainty. This current rally is fueled

by relief that the system is not going to crash (at least soon) and a lot of money is coming off the sidelines to buy financials. Who's selling? Could it

be the pros? It would be a great time to sell BAC or C, to take advantage this rally. New equity issues have been mandated, there will be a chance

to buy back your shares at post dillution (lower) prices.

 

[SharperDingaan]

 

This entire question could be reframed as

"I have a ton of unrealized gains from choosing well, what should I do with it?"  But frankly a monkey might have done just as well, if it had bought at the same time. ie: gains almost entirely attributable to market timing.

 

The overwhelming answer has been 'hedge the gain'; by outright sale, option use, etc.

Hedging is insurance, and the cost is the opportunity loss if you end up needing to buy back your position for something more than you sold it at. If you buy insurance you expect to pay a premium - & this is no different. 

 

If your wealth is doubling every 6 months, & you're hedged against potential loss - why do you suddenly think that you need a new strategy? You are where you are because you were concentrated, you know those companies better than you know the market, and you are hedged against any price drop that Mr Market might suddenly put on those companies. Your only decision should be whether you maintain the same portfolio weighting or not.

 

Both industry & the fed have a vested interest in convincing the market that this rally `is for real`.

If they are successfull, bankers might well keep the `too big to fail`card & escape being broken up; the fed will see their stimulus take off & the $ on the sidelines come back in; the industry will see a dramatic rise in fee income, hedge funds will escape redemption requests, & the related service industries will see a material increase in their business volume. Hype.

 

The `funny number` MTMs, `Zombie` banks, collapsing credit, nationalizations & bankruptcies haven`t gone away & may well actually be getting a lot worse (AIG); ie: there is very good reason to be hedged.

 

Just because the siren is slobbering all over your ear,

doesn`t mean that you have to act!

 

SD

 

 

 

 

[enoch01]

I think it may be time to consider that perhaps the value investing paradigm is dead (at least until we reenter a period of global growth).

It may be that it only works in long term bull markets and is in reality a variation of the "rising tide floats all boats" effect.  By carefully picking

"boats" with more favourable metrics (value, margin of safety), the value investor trades dips in submarkets, hence beating the average.

Since the market topped in August of 2007, value portfolios have taken a huge hit, in many cases a much larger one that the indexes.

 

On the contrary.  I would say the application of value principles today is going to make some people very rich in the years to come.

 

Seth Klarman was saying a couple of years ago that it was a tough time to be a value investor.  Cumming and Steinberg would lament at annual meetings that private equity firms were sucking up potential purchases because they were willing to pay more (with borrowed money, of course).  Berkshire was drowning in cash because Buffett couldn't find deals.  Faifax was buying insurance on the financial system that turned out to be what I'll call generationally cheap.

 

In my reading of history (certainly not in my experience - I'm too young), there have been few times better than today to be a value investor.  Well, maybe not today, perhaps early March.

 

Volatility and a long-term perspective are the friend of the value investor.  For example, when the price of a company like Leucadia drops 80%, then more than doubles, all in the span of about a year, to me that indicates a fruitful environment.

 

E

 

[Packer16]

I have also been thinking about this and reading about the 1930's to see how close we are the situation then.  The common attributes are that there was a debt-induced bubble in both equities and real estate that became unsustainable.  The resulting work-out of debt is the period we are in now.  In the 1930's, the US was the #1 economy followed by UK then Germany and France.  The German's had a more of a command-based economy (similar to Japan today).  Some of the differences are a social safety net in developed countries (which will support consumer spending), the US being a debtor country versus a creditor country, monetary easing and up to now no major trade barriers.

 

I think these factors will mute or maybe negate the effects of deflation in US dollars.  The result maybe that the market stays where it is now for a few years until China starts to kick-in with the US slowly increasing.  I think the days of 3 - 4 % real GDP growth are gone for now.  The recovery will be in the 1 - 2% growth rate due to less leverage and more taxes (and corresponding inefficient redistribution of resources).  I think rising interest could either constrain gov't spending or lead to more inflation.  I think the later is easier politically but over the long-term may get us back into a stagflation situation.

 

I still think value investing will do well and is not obsolete.  Most of the value burn-outs I have seen were heavily investing in financial firms they did not understand or in resource firms that have got hot with decline in resource prices.

 

Packer      

[Guest Broxburnboy]

"I would say the application of value principles today is going to make some people very rich in the years to come."

 

My point exactly.. the key word is "today", but only if today proves to be near bottom of this regression. I know many value investors

are famous for great runs after the market bottomed in 1930. I'm not aware of any who bought and held in the summer of 1929, pre-crash

and pre-depression.

 

[woodstove]

Very interesting discussion!  I learn so much from you guys!

 

My market call starts with what I consider the economic

probability, continued deterioration of the real economy:

- less discretionary spending, by consumers and businesses

- less consumer credit

- less small business credit, more expensive mid-biz credit

- lower employment

- more households in acute distress as reserves run low

- more compromises need to be made with necessities

 

==> Eventual adjustment of stock market outlook to same.

- Selloff of various stocks related eg to consumer spending.

 

Investing safe havens:

- cash

- quality gold & silver stocks (NGD, SLW)

- quality oil & gas stocks (IMO)

- quality utilities (ACO.X)

- Berkshire and Fairfax

 

In particular regarding IMO, gasoline pump prices have

been going up quite a bit recently.  Not at all clear why

based on oil price.  But don't have to understand why,

just watch the cash flows.  Cash flowing into refiners

and production companies, not flowing out to drillers,

so some must be sticking somewhere in IMO's vicinity.

 

There are some great opportunities outside of the above,

but I'm content to wait for economic tide to change its

direction before going for broader lower quality choices.

[Uccmal]

I was buying stuff however I could in mid march.

 

Lately I have been selling a few things in order to:

1) Have cash available for future buys in areas I am more comfortable with:  autoparts, gas, manufacturers.

2) Capital preservation.  I got caught with my pants down going into late February - the resounding negative reaction to FFHs annual numbers was what caused the most problem.  That threw me into a situation where I had to sell things at a loss to raise money to buy other things.  I will never allow this to happen.

 

Since March, I have made back all that I lost going into that dip, taken alot more money off the sidelines.  If FFH went back up to its highs I would actually be up for 2009. 

 

I am unwilling to buy much right now. 

 

I am wondering if I have become anchored to those low prices.  I need to think this through a bit.  I bought LUK at such a low price I have doubled my money.  This however sets the bar ultra low for prices.  I am philosphizing if it is a bad thing or if PARTNER24 has the right idea and I should make more effort to do nothing at all. 

[UhuruPeak]

Ucc,

 

 

I know I have DEFINITELY become anchored to some prices.  WFC for example...  I won't touch it even at $20 and probably not at $15.  I passed up on it at $8 because it was "outside my circle of competence", or rather because I was too chicken - now I have non-buyers' regret.  While the circle of competence argument is relatively valid on this one, I'd have the same story on other companies that I understand much better, such as power producer NRG for example.

 

 

Who ever said we investment geniuses were completely rational?    :o

[vinod1]

 

I'm not saying that you won't do fine selling at a lower discount to IV. But if you plan to load up again at a greater discount to IV, then you are in reality speculating to buy from a greater fool?

This is also true if you buy another issue immediately - indeed, in this case you believe your own estimate of IV is more accurate than the "greater fool".

Instead, why not opt for a greater margin of safety by selling (possibly short) an issue trading (much) higher than IV instead of selling the issue trading at a small discount to IV ?

Shouldn't this improve either your odds and/or your gains compared to selling issues below IV?

 

But we're moving further away from the point: isn't a market call in reality just a Mr. Market call, trying to estimate the odds for the behavior of Mr. Market?

 

Cheers

 

The basic principle I am adhering to is that I want to own more of a particular security at a greater discount to IV than at a lower discount to IV. For example, I would want to have a 10% position when it is trading at 50% to IV and maybe a 8% position when it is trading at 70% of IV. I categorize my investments  into specific types such as exceptional business (due to either a great business moat, great jockey, etc), net-nets, discount to break-up/liquidation value, arbitrage, discount to debt debt capacity, etc. The principle above is what I would apply to securities that fall under exceptional business like Berkshire. I intend to hold them forever but plan to take advantage of market fluctuations by increasing/decreasing allocation in inverse proportion to market movements (or more accurately price to IV).

 

I would never short as it is very risky - market can remain irrational longer than I can stay solvent.

 

I do not disagree with you at all that regarding taking action based on our expectations of Market. That is what I was asking Viking. I reduced a little bit based on above, not because I am expecting Market to go down. It seems to me that market might go down, but I do not want to take any action based on that expectation.

 

Vinod

[Guest kawikaho]

Viking,

 

What price did you buy ORH?  Based on 0.8x book, i'm guessing around 36? 

 

I've basically missed majority of this rally.  It was all due to a damn trip to New Zealand.  New Zealand, by the way, has the worst wireless broadband infrastructure than any country I've ever been to.  I'm now looking at companies in solid industries, trading single digit PE, with over 5% dividend, and even better if it's a discount to book.  MRK, PG, NRG, and possibly Boeing at 40 (I really like the long term performance of Boeing), MSFT, and GE.  The most important thing to me is market cap, before I invest.  Companies approaching 100 billion market cap is a no go, unless it's a company that has fluctuated from 300 billion like MSFT or GE.  At half their prices, if price recovery can occur in 7-8 years, then you get 10% CAGR and that's not that bad.  If it can happen in 5 years, like most of the large caps did after 2002, then you get 15% CAGR, and that's pretty good.  In these cases, I don't buy into the "buy and hold".  That strategy will go nowhere with large caps.  You have to buy and trade the large caps.  I bought IBM in 2003 at 60, sold it at 120 in 2008.  Did this solely on market cap and the realization that IBM is a large cap that's stable and solid.  I bought WFC, and sold, but that was last year and made 50%.  I missed it at 17 a few weeks ago, and now i'm wondering what the valuation of this large cap could be.  I can definitely see WFC reach a 180 billion market cap.

 

By the way, one very troubling thing I've been noticing in the past several months is the high correlation of oil prices with the S&P.  It's nearly 1.0.  That's troubling in so many different ways, that it's beginning to piss me off.  What this implies is that with all these bailouts and market rescue measures, there is an effective hidden tax being issued to the consumer: namely, higher prices due to oil.  I sense that with a recovery in the cards by the end of this year, we will see a return to much higher prices in everything.  The troubling aspect is this is going to happen regardless of demand.  Demand for oil has been going down.  Supply, as we know by the surplus inventories, has been going up.  Why the rebound in oil?  Speculation in the "free" markets.  It fucking sucks.  That pisses me off more than anything.  If some business professor tells me the market is efficient and rational, I'm going to kick his ass.  Unemployment is nearing double digits across the U.S., and is already over 10% in 12 states.  Higher prices would be like another kick in the nuts.

[Mungerville]

My views, portfolio and track-record are very similar to Viking's.  The only difference is instead of holding so much cash I am short the Russell and long JNJ and KO and have some ORH calls.  So if the latter three beat the Russell, it'll be better than cash.  If they don't, it'll be worse. 

 

 

 

 

 

[locutusoftexas]

I have decided to force myself to take profits periodically after a lifetime of buying and holding. This requires a strategy for selling, which I have now finalized after studying the last 10 years of market and economic statistics that I have been recording. The main reason for this is that over the last few years, I have realized that stocks are much riskier than Wall Street would have us believe. (Okay, so I am slow.) Reviewing my old copy of Ten Years of Wall Street, published by Bernie Winkelman in 1932, I was particularly struck by the much higher dividends that high quality stocks paid then (at least in the early 1920s) relative to bonds, in recognition of the much greater risk of equities.  Given that, in bankruptcy proceedings, the equity holders often receive nothing and that bankruptcy is the eventual fate of a high percentage of corporations (maybe after many years), the riskiness of stocks becomes much more apparent.

 

After years of investing, one also realizes that the machinery of Wall Street (including supposedly objective information sources) is designed to separate the public from its money in return for (now virtual) pieces of paper called stocks.  Winkelman said this as well. The above fact that dividend yields have not recognized the greater risks of equities for many decades further tells me who the patsy is (in the words of Warren's poker table story).

 

So where do I think that the market stands? In a word, I see the market as "flat" on average and over a time scale of several months. Currently I would put its range at SP500 of 900 +/- 30%.  However, my trend indicator on that time scale is close to becoming "positive" from "flat." My monetary indicator is positive, but is moving toward flat.  So I see us in an improving market, but I have no current illusion that we have begun a new bull market, and I see another dive below 800 as a possibility.

 

Tex

[Guest Broxburnboy]

I have decided to force myself to take profits periodically after a lifetime of buying and holding. This requires a strategy for selling, which I have now finalized after studying the last 10 years of market and economic statistics that I have been recording. The main reason for this is that over the last few years, I have realized that stocks are much riskier than Wall Street would have us believe.

 

Yes stocks are risky, but some are riskier than others. It is also true that bonds have proven to be riskier than advertised, in fact the whole credit bubble is built on poor risk assessment. Trading shares in viable companies for cash (shares in shaky sovereign debt) may not be a good trade either. It may be that shares in companies who profitably manufacture essential commodities will hold their relative value best. If  inflation is in the cards, then such stocks will appreciate lockstep with inflation, cash will lose.

[bargainman]

I have decided to force myself to take profits periodically after a lifetime of buying and holding. This requires a strategy for selling, which I have now finalized after studying the last 10 years of market and economic statistics that I have been recording. The main reason for this is that over the last few years, I have realized that stocks are much riskier than Wall Street would have us believe.

 

Tex, I'm curious what your newly minted selling strategy is?  I've been thinking about this lately too.  I'm thinking about a modified version of value cost averaging, but haven't really worked out a set of guidelines or anything.  I want something that's at least reasonably mechanical so I automatically take profits when stocks go up and invest more as they go down.  Apparently some study found that dollar cost averaging was no better than just randomly buying, whereas value cost averaging was statistically better. 

 

It's an interesting point that the marketing has been relentless on the 'long term stock ownership' front.  I know Mauldin has written at length about the fallacy of this argument (or has published letters by others who have). 

[locutusoftexas]

Bargainman,

 

Thank you for your interest. My goal is not to trade on a short time scale, but rather to be in the market when the indication is positive on a six-month time scale and to begin taking profits when that changes to flat or negative.

 

I am afraid that what I am doing is nothing magical. I plan to track Fed moves to increase or decrease the money supply and to track increases or decreases in key interest rates, as a method of estimating the future course of the economy. This includes derived indicators such as the inverted yield curve, which would have kept me out of the market last year long enough to see that really bad things were happening  At the same time, I plan to use what I consider to be a reliable indicator of the stock market trend on a time scale of 6-10 months.  The key is to start selling when this longer term trend indicator is flat or moving downward and to buy when it turns positive.

 

I realize how naive this sounds, but the net effect is to reduce the risk of holding stocks by controlling market exposure.  This means giving up the maximum return from holding over a 20-year period. As a value investor, I have resisted this, especially when I have held superior companies like FFH and LUK.

 

The key then is to find a longer term trend indicator that appears to work.  I am reluctant to give the details of what I am using. However, I can say that after studying the data over the last 10+ years, I have found that a fairly well-known indicator has been misinterpreted to be a contrarian signal. The logic seemed inescapable but in fact it did not hold up under comparison to historical indexes. Instead it appears to work well as a coarse trend indicator.

 

I must admit that using only 10-15 years of data lends doubt to my findings.  However, one only lives so long.

 

On the other hand, what I tried to say in my previous post is that after around 30 years of studying the stock market, I can only conclude that not much has changed over the last 80 years. Rather, companies do not last forever and the stock holders get screwed in bankruptcy. By the best measure -- dividends (cold hard cash) -- current equity investors (in well-known companies) are not being compensated for the risk. The only thing that makes sense for a guy like me (who does not want to spend his life trading daily) is the following:

 

(1) Diversify with an index.

(2) Be wary of stocks that do not pay a dividend greater than the prevailing short-term to mid-term interest rate, since otherwise one is not being compensated for the risk of holding stocks.

(3) Take profits and pay the capital gains taxes (hard medicine to take).

(4) Control risk. An example is the point of view that I offer above.  This means giving up maximum return with minimum taxes.

(5) Determine the prevailing opinion on Wall Street and treat it as falsehood (for example, the common wisdom that a recession is not in force until two consecutive quarters of negative GDP growth have occurred).

(6) Identify the main question that is being asked on Wall Street and assume that the most market-damaging alternative is correct (again, early in 2008, CNBC endlessly debated whether the country was in recession and of course the answer was already, "yes.").

 

I hope that this helps. I must admit that I will find it difficult to sell stocks of companies that I believe in, especially when I doubled down on LUK near its recent lows.

 

Best wishes,

Tex

[Mandeep]

NRG does look cheap...still just on a P/E basis. Wasn't this a Berkshire holding?

 

 

 

[Guest kawikaho]

Yeah, i'm looking at NRG right now.  It just hit my price target of 19 today.  I'm still watching it.  Anyone like Verizon?  It pays out a huge dividend.  Anyone know of any good WiMax plays?  I think that will be the future.  I can only think of Alvarion, and Clearwire.

[Mandeep]

Guys, check out CRM, salesforce.com. It's trading at like 114 P/E. WTH is going on? lol.

 

I like verizon, but I wonder if its a company you can trust to be around, no idea.

Warren would have bought it lol, but he didn't

 

[UhuruPeak]

I don't think BRK owned NRG; they made an offer on Constellation, or "CEG".  NRG is about to be purchased by Exellon (EXC) for 0.485 share of EXC; the market has constantly discounted the NRG shares between 10 and 20% and I am completely stumped by this discount; talking to people in the industry doesn't help, many are just clueless as well.

 

 

NRG is one of the 4 finalists to get  federal loan money to build a new nuclear plan; finally, they just snapped the second biggest electric retailer in Texas (Reliant Energy) for a mere $287M + working capital, or less than $400M total; my own estimate of what such a retailer should trade for is closer to $2 or $3B - say the value went down significantly of late due to higher cost of capital and repricing or risk and everything, the sale price still doesn't make any sense to me.  So in other words, NRG actually showed a significant IV gain very recently.  If EXC manages to snap up NRG (51% of the shares have already been tendered, and some Federal regulators just gave their approval yesterday), it will be a steal as well.

 

 

The main thing that weights on all these power producers' stock price is the price of power:  as the economy has slowed down, the demand for electricity has dropped everywhere, putting pressure on producers' profitability (but helping the retailers', Reliant Energy among others).  Sooner or later though, the price of power will go back up and the stock price should follow.

 

 

Disclosure:  long another power producer (RRI Energy); I haven't pulled the trigger on NRG because I just suck my thumb all day long but I'll kick myself if I let it slip.

[benhacker]

Mandeep,

 

Guys, check out CRM, salesforce.com. It's trading at like 114 P/E. WTH is going on?

I'd avoid looking at the P/E of a company without looking at the cash/accrual accounting detail and most importantly its business model and moat.  I don't own CRM, but some folks in an investment club I'm in have been digging into it.  They may have the only model I've ever seen that is stickier than Microsoft's OS frachise.  Simply stunning.  Not sure it's a bargain, but at $4B it may be.

 

Uhuru,

 

I don't think BRK owned NRG; they made an offer on Constellation, or "CEG".

See here --> http://www.sec.gov/Archives/edgar/data/1067983/000095013409010823/a52403e13fvhr.txt  

 

Buffett bought NRG and you spaced it.  :-) Happened 9-12 months back.

 

I'd taken a look at NRG and EXC and both looked good, but outside of my circle unfourtunately.

 

Ben

 

[UhuruPeak]

Thx for making me look stupid Ben, now everyone knows!  :)  Ok, so I did miss it.  Now, did BRK buy 126,700 shares for $7,200,000?  Besides the fact that it doesn't look like a Buffett transaction, it also comes to almost $57 a share, or higher than it has ever been according to Yahoo's chart.  Looks like I am missing something else too :-[

[benhacker]

Uhuru, you are really off your game. ;-)

 

7.2m SHARES, and a value of $126m

 

The above says nothing about purchase price or cost basis.  A 13HR form is just a snapshot... this one from 3/31/2009.  Just do some googling and you'll find some articles on when the NRG purchase was first disclosed... it was in November of last year I think.

 

Cheers,

 

Ben

[UhuruPeak]

I guess you have your answer - yes I'm completely off my rockers.  Geez, I need a beer!

 

 

I'll try to redeem myself a little by giving you the high level view on how to look at power producers:  they are basically call options on the price of power - which more often than not depends on the price of natural gas.  So basically, NRG & CEG & EXC & others will rise at the same time that CHK (Chesapeake) or other Natural Gas producers would rise.  The power producers are often regulated and therefore operate in a "cost+" environment, but even the ones who are mostly unregulated (in Texas for example) will still have less volatile earnings than the pure NG producers.  In other words, the leverage is typically less and you can sleep a little better.  Now, buying any of these companies is like buying up a big oil or big mining company: you need to believe that Oil, Gas, Uranium, Copper or Gold is going up.  I bought a lot of gold/silver miners a few years ago, but got out a year or two ago when the story of the metal didn't look as compelling to me anymore. I still think the Natural Gas story is good, the current price doesn't strike me as sustainable (we are at the lowest prices since 2002, before even taking inflation into account). I don't have the same confidence level about the current prices of Oil, Copper or Gold - it may be the same, or it may not.

 

 

 

Ben, thanks again for the public spanking!  8)