Biding my time

Markets have been hit primarily because of  Emerging Market jitters as the currencies of some of the smaller countries like Turkey and Argentina have taken a big dive. This is apparently the result of QE tapering fears and China showing a continued slowdown. You can pretty much pick any excuse; when the market is frothy from a sentiment perspective as I described in my previous post, it becomes much more vulnerable to negative news.

If we continue to see negative consequences to the unwinding of QE, whether it's actually responsible for it or not, then it's likely going to be the case that the upside of the market will be capped until QE tappering has ended or is close to ending and the market senses that there is no serious fallout from it. This means that we could see a choppy or down market for the majority of the year much like 1994 and 2004, which were also years where the Fed was taking away monetary stimulus. Mind you, in 1994 and 2004 there was outright tightening via rate hikes whereas this time around it's only unwinding of QE and monetary conditions would still be very accommodating without QE. However, there's this wide held belief that the market is dependent on QE and I'm sure you've see the charts which show the correlation of the market's performance with every round of QE.  This effect could be more psychological than anything much like how a child feels brave if he has his favorite blanky and so if you deprive this child from his blanky he will be afraid and has to go cold turkey for a while before he realizes that there was nothing to be afraid of all along. By no means do I claim to know the actual impact of QE or lack thereof but I suspect that it's not as critical as many are suggesting. One thing I'm quite sure of is that QE is no magic bullet and that any positive economic response it may have achieved was because it was initiated at the right time, i.e. it was initiated at a time where the economy had largely purged itself from the excesses of the prior cycle and pessimism was thick; therefore the economy had a lot of pent up upside potential making it more likely to react effectively to stimulus. If for example QE was initiated in early 2008 when the economy was only just beginning to rollover I doubt very much it would have prevented a major bear market. Anyhow, that's my worthless 2 cents on the subject. Debating these kind of things can be interesting but then you start getting into the realm of dogma and the more dogmatic your beliefs are, the less investable they are. 

The bottom line for me is that I want to see the froth taken out of this market before I get can comfortable committing more to it and when this happens it will show up in the same indicators that warned me about the froth. As I said in a recent post, I got the distinct feeling that there are too many weak longs in the market who are only long because of momentum. Now we are probably starting to see these longs bail. I don't know how long this process will take and I'm sure there's going to be sharp bounces in the interim and perhaps we're gonna get one of those soon,  but I'm just going to bide my time keeping my bat on my shoulder for the most part while waiting for the medium term risk-reward situation to significantly improve. If I see something really, really enticing I should probably go for it - at least partially, and perhaps put on a hedge. I don't want to be a hostage to the broad market but I'm well aware of the rising tide lifting all boats phenomenon and how this applies to the downside as well.

Beware the dreaded P6

I find myself in the bear camp these past couple of months not because of the dogmatic, miserable fuck bullshit from the permabears which helped bankrupt God knows how many traders, but because the evidence just keeps piling up.  There's a market strategist named Don Hays who I have followed off and on since 2000. I think the word "followed" is not the right way to describe it...reading his commentary is more accurate. Anyhow, he's a top down strategist and his "system" consists of 3 pillars which are valuation, monetary conditions and psychology (investor sentiment). I like to keep tabs on the last pillar, psychology because it tends to be pretty good at marking significant medium and LT turning points. This pillar of his system is composed of a variety of sentiment indicators such as investor survey's, insider activity and fund flows. Psychology is ranked in 6 levels ranges from P1 to P6 with P1 being the most bullish condition for the market (bearish sentiment is extreme) and P6 the most bearish for the market (bullish sentiment is extreme). It is rare to see P1 and P6 readings and when they get triggered they almost always happen near significant turning points in the market. The only time a P1 reading was notably early was during the 2008 crash, which is understandable given the once in century type collapse that it was.

The bad news for the bulls is that a P6 reading was just triggered. The last time it happened was in June of 2011 near the peak of the market which led to that 20% correction (A rare P1 reading was then registered near the depths of that nasty correction). The other time prior to 2011 a P6 was registered was in May 2008 which was the selling opportunity of a lifetime.

It's important however to keep things into context. In bull market conditions, extreme bullish sentiment  leads only to corrections (which can be scary) while in bear markets they mark the end of a dead cat bounce which then leads to major damage via new lows (as was the case in 2008). So, a P6 doesn't automatically mean the end of the world. In 2004 for example, a P6 reading was registered in March but only led to a 10% correction which took 6 months to play out before the bull market resumed with a vengeance. Having said that though, it's clearly not a good time to be putting money to work during a P6 condition even in a bull market for odds are very high you will be able to get better prices if you wait. It also seems likely the correction will be greater than 10% given the gains we've seen in the recent 2 years and let's face it, after a 165% run in 5 years, we could be in for a major scare much like in 1987 which occurred 5 years after a great 5 year run as well.

So, this also begs the question. Should I consider making a bearish play here? The short answer is yes but because we are not in a bear market and tops can take several weeks to form especially when you have this kind of momentum with the market still very close to the highs, be prepared to be very frustrated if you attempt to do so and so give yourself plenty of staying power. Buying long dated puts would be the best solution. I am strongly considering to do so but since I'm already in 60% cash with my major holding non-correlated to the market I'm already defensively positioned and can patiently wait for the market to show signs of cracking first while keeping my sanity in tact. If history is any guide we will see a couple of small dips followed by sharp rebounds before the "real dip" starts. If I'm wrong and the market simply tanks on a dime then at least I won't be caught with my pants down as I'm already 60% in cash. The bottom line for me is that I can be patient with any attempt to profit on any downside. If I was closer to fully invested then I'd be raising cash in a hurry.

Bottom line here is that it appears the risk/reward for the market in the medium term (6-12 months) is piss poor. We can certainty go higher before we go lower but it would very likely be a running on fumes/blow-off type move in my opinion. The last time I felt this negative about the market's prospects in the medium term was in the early summer of 2011.

Greenstar, my glory or my undoing

Never before have I invested in a company whereby the operating results/fundamentals have been so disconnected from the stock price for such a long period of time and to such a large degree. In the CFA level 3 program there's a section which describes "chronic inefficiencies" of the market whereby there sometimes can exist a mispricing of an asset that can last for a long time due to either structural or behavioral factors. Greenstar is clearly suffering from this and it's making me suffer.

When I first bought the stock just over a year ago at .50 it was trading at 2 times 2012 earnings. A ridiculous discount given how clean the balance sheet was and how constantly profitable the company has been. The knock against the company is that it's a reverse takeover Chinese based company, the same type that Sino Forrest was and so automatically and idiotically, many investors view the company as having high scam risk even though the company has done nothing in any way suggest it is so and they have a pile of cash in the bank. It's no different than labeling me a mafioso just because I have Sicilian blood. In 2013, to combat the skepticism, the company started paying an enticing dividend, added several Canadians to the board. and then hiked the dividend by 50% in the summer. The company also continued to post excellent results with growth in profits likely to be about 35% in 2013 vs 2012. The Canadian dollar has fallen significantly vs the RMB which added further to equity via currency translation gains. I estimate that book value to be about 1.90/dilulted share as of the end of 2013. So, given all of these very positive developments in 2013 you would think that the stock would get a more respectable multiple than a measily 2 times earnings by year end...well, you thought wrong....or at least I did. While the stock price did go up from a year ago, it still trades at 2 times earnings. In the summer it did appear that the stock was finally getting some well deserved respect but that didn't last long and it's been a rather frustrating and agonizing slide since then. I talked about how there is an overhang from what appears to be 3 sellers out there, one in particular that is trading under the annoymous broker. I dealt with a similar situation with hwo.to last year whereby the company has done nothing wrong operationally speaking, yet the stock price drifted lower and lower for months to very undervalued levels primarily because of one asshole who traded out of UBS relentlessly pounding bids. When this happens not only do you get very frustrated but you start to wonder if someone knows something that you don't and your frustration turns to worry and doubt. Eventually, after 5 months of torture, the stock broke out of its funk and eventually soared to significant new highs which means those who were relentlessly selling knew fuck all, but I'm sure there were lot of people who either threw in the towel during those 5 months of hell or sold very early in the recovery thinking the stock would retrace again. 

As far as I can tell, there is nothing at all that suggests something is wrong with GRE's business. In fact, it's the opposite. The company just announced major expansion plans and I conservatively estimate the company will be making $40M in annual profit in 2015. Put this into perspective with the current $26M market cap of the company.... it's fucking beyond asinine, beyond insane. Now, there is going to be a private placement closing next week which will bring about a dilution to existing shareholders. I'm not thrilled that they are doing it at such a cheap price but they need Canadian funds to do an acquisition and the expansion they have planned will require all of the cash they have in the bank plus an increase in working capital. But even with the increased share count due to the PP, I conservatively estimate that fully diluted EPS in 2015 will be at least $1 which means the stock price is trading at 0.84 times 2015 earnings!  How the fuck can the stock price not soar after this news? Anytime the stock tries to pop on good news, sellers come in aggressively hitting bids knocking it down again and the buyers back off. What are they thinking? They can easily fetch higher prices if they wanted to. They are such fucking idiots. 

At some point, I figure that the market is going to give GRE the respect it deserves. I said this at least a few times during the first year when I bought hwo.to. It took 2 years after I bought for the market to finally come to its senses and so I wonder if it will take the same amount of time with GRE....it may take even longer given that the company is Chinese, but there's only so long the market can penalize a company that keeps producing these kinds of results while consistently raising dividend payments as the company grows, and speaking of which, based upon the growth that's to come in 2015, I think there's a good chance of  another 50% hike in the dividend for 2015 which would be announced this summer if history repeats. 

In the meantime I may very well continue to suffer and be frustrated beyond limits. The only way I can combat this is to simply not look at the stock price day to day and only monitor fundamental developments. I can't second guess myself thinking that maybe someone knows something I don't. I've made my move and I'm sticking with it unless there's clear evidence that something is wrong.  I said this once to someone; as a value investor the best strategy is to buy a cheap stock you've done your homework on and have strong convictions, turn off your computer and go live in a cave for a year before checking the price because it can take a long time for the market to recognize the value that's there.  And yes, these extreme value disconnects CAN and DO happen especially with microcap stocks. The market is often NOT effecient and so it's wrong to assume all cheap stocks are "cheap for good reasons". Case in point is with bev.to. In early 2009 the stock was trading at 0.23 when they announced a major government contract which pretty much guaranteed at least 0.50-0.60/share in earnings. What did the stock do after the announcement? Fuck all and it did fuck all for several weeks later and only really started moving when the money from this contract actually started coming in. The stock price got as high as $3.45 just over a year after the contract announcement. I bought at 0.50 only because I discovered it a little late. Why was the market so slow to react to such good news? Because the company nearly went bankrupt  a couple years prior, plagued by scandal from its former CEO and so nobody trusted the company anymore even though they restructured and got rid of old mgmt. A similar thing happened with hwo.to. The former CEO Jed Wood nearly ran the company into the ground in 2008. They booted him out and restructured but despite producing great results early on, the market did not give the company any benefit of the doubt for years due to its history and its operations in PNG which was deemed risky, but eventually it simply became too hard to ignore the strong balance sheet and great results the company was delivering and the company finally got it's due.  The lesson I learned and profited fro is that in the LT, good financial performance gets recognized by the market one way or another and there's only so long unwarranted negative sentiment can hold a stock back, but I also know the journey a shareholder must take to see this through is filled with frustration and doubts galore. In hindsight the best thing to do is like I said earlier, don't look at the stock price for long periods of time and simply focus on the results that are being delivered and other fundamental factors. 

Now I just need to take my own advice before I lose my nerve. I may not post for a while unless I find some new stocks to buy which I'm currently on the hunt for. 

Tough call for 2014

I'm not so sure what's in store for the market in 2014. I'm thinking we could see a flat year with a major scare sometime mid year but I don't say this with any great conviction and I'll be quick to change my mind if evidence suggests so because I'm still LT bullish. Last year I was expecting the good times to continue in 2013 and we certainly saw that, but now that we've had a hell of a run these past 2 years,  it sure seems like the market is due for some sort of consolidation especially given some serious warning signs flashing out there. I'm not alone is such a view and so if the market is due for at least a major shake out  it's quite likely going to be elusive and frustrating for anyone trying to time it. Many people I'm sure have been laid to waste in recent years betting on corrections.

The thing that concerns me in the medium term is that I get the distinct feeling that there's a lot of weak longs in the market, i.e. those who are long stocks simply due to momentum and so it follows that they will exit en masse once the momentum is gone and violations of trend lines, moving averages and other useless t/a garbage triggers stops. In 2013 margin debt rose substantially and we've seen retail come back in a big way. None of this is as dire for the market long term as the bears are suggesting (and man were they premature with such worries in 2013)  but it does suggest that the market is frothy/vulnerable in the medium term similar to how it was in the first half of 2011 after 2 strong years which saw margin debt spike as well. Another thing that suggests the market is ahead of itself is how some really sharp value managers with great track records are having a hard time finding any bargains and so they are sitting on a large cash position. Value line appreciation potential index is at a multi-decade low which is bearish too. Finally there's sentiment as per newsletter writers, NAAIM and AAII which also indicate too much enthusiasm for equities in the short to medium term.

Having said this though, the conditions for a bull market peak are not present, namely,  monetary conditions are still ultra loose even with tapering on the horizon, inflation is not a threat and public greed/complacency is absent. How do you test this notion? Ask your neighbors what they feel about the economy and the stock market. How does the media perceive the strength of the economy? I doubt very much you can make the case that the public is optimistic yet alone complacent. An objective measure of such is consumer confidence. It's currently at 83. Bull market peaks have been made when confidence hits 100+ for at least a few months. I  posted the investor "risk appetite" chart not too long ago which showed investors are not yet at the "risk loving" stage which again indicates an absence of the type of greed you see at bull market peaks.

So, the bottom line here is be cautious for the medium term but still optimistic long term. If you see a great individual stock opportunity by all means go for it, especially if it tends to not trade in tandem with the general market, but keep healthy cash reserve until we see the "medium term froth" get washed out. I suspect if we are going to get a nasty correction it won't happen until sometime closer to mid year with many little dips and headfakes along the way and so it's quite possible, like in the first half of 2011, that the market goes higher first before going lower in a big way but this is more of a guess than anything. Don't get too cute. Be disciplined.

I'm currently holding 60% cash with the majority of my equity exposure in Greenstar. I'll talk about GRE next post.

Farwell 2013

I've never been so sick during the holidays as I have been. It's been 3 weeks of off and on colds including what I think was the flu last week and I still have this annoying cough that won't go away. I ended the year with a 32% gain and just like I said last year at this time, I'm not satisfied with this gain.  I don't say this out of arrogance or greed but because like last year, I don't believe my holdings; in this case Greenstar, is anywhere close to being properly valued despite making gains on the year. If the stock just traded at 3 times 2013 earnings at year end,  it would be at $1.30 which would have resulted in a 58% gain instead.

I've been trading/investing full time since the start of 2009 which makes this 5 years. I've averaged an annual rate of return of 25% during this time. My goal was to achieve an average return of 30%+  and so I fell short of my goal. I think I know why. The main reason was lack of conviction early on. For most of 2009 I was sitting primarily in cash as I didn't have much conviction on either side of the market but around summer time I became LT bullish and felt more comfortable doing the buy and hold thing. I ended that year up only 14% and I really missed out on some of the low hanging fruit. There was some staggering gains in some metals and materials small cap stocks I had on my watchlist but I failed to pull the trigger. I did really well with bev.to which I purchased in Sept 2009 and sold in March 2010 but I should have bought a lot more shares that I did. 2010 was my best year as I had a 50% gain largely due to bev.to but as I said, if I had more conviction that could have easily been a 75%+ year. 

Despite the healthy gains I've made, it hasn't always been a bed roses. Throughout these 5 years there's been ups, downs, boredom, excitement, frustration, despair and even tears. Due to my concentrated style, especially the past 2 years, I've been on several roller coaster rides and let me tell you, I fucking hate roller coasters. I haven't been on a real one for over 20 years. The swings I went through however, where not going from -10% to +15% type swings, it more like +40% to +15% type. 

I usually review the good the bad and the ugly for the year that has passed but I'm going to do so this time in regards to the past 5 years.

The good

Over the past 5 years I have achieved strong annual returns every year without any down years blowing away the performance of the TSX and probably over 90% of the hedge fund universe.  Although account volatility was high (which was to be expected given my approach), I didn't have downside volatility i.e. I was never in the red during the year aside from minor losses early in a couple of years (< 5%) .  I was able to have success all on my own. I followed nobody else's trades. I'm proud that in 2011 I returned  24% while most world indices had negative returns.  I did very well in avoiding losses. The biggest loss on any one position that I took was about 4% of my account value which is pretty low considering that I take concentrated positions. I have learned and developed over these years and found my niche which is micro cap value investing.

The bad 

As good as my numbers are they could have been better....a lot better have I had more conviction at times especially in the earlier years. My cash position was probably too high during these past 5 years. On average I would say that my cash position was 40%. When you have a concentrated portfolio I think it's wise to have significant cash on hand as a  reserve in case one of your positions get's  blown up but I definitely think I held too much cash. I think I also got too comfortable and lazy at times with holding only a few positions as I felt there was no need to look for other opportunities.

The ugly 

I missed out on some really big winners because I either hesitated too much or was too picky with my conditions for entry. I made some undisciplined moves, namely overtrading when I should have been patiently holding. I have put myself under unnecessary emotional stress and wasted lots of time by watching my positions intraday several times a day like a day trader would. I didn't do this every day but often enough for it be a significant problem. This is something that must stop.

Going forward my goal is to once again get above the 30% return mark. I want to do better, but I know after a 5 year bull run, it's going to be harder to find the type of long side opportunities that I uncovered which made me a lot of money. I use a value approach but I'm in no way locked into any one style of investing/trading. The whole point of being in the market is to make money and I will do so in a way I believe gives me the bets odds given the conditions that are present. When conditions change I need to adjust accordingly.

I'll talk about the 2014 outlook next post.

Santa says hwo! hwo! hwo! Merry Christmas!

hwo.to  has been on a tear because of a series of promotional mentions. First it was Jason Donville which sent the stock over $3 for a while before it later pulled back but then it got coverage by a couple of CDN firms a few weeks later with price targets of $4+ and another mention on BNN by some other guy. Is this additional attention a co-incidence or are people riding the coat tails of  Donville, who right now is one of the gurus du jour here in Canada? You know what? I don't care. This is a gift and I will gladly receive it.  I've been selling into this strength and I really stepped up the selling Friday as the stock had a big surge. I'm only left with a residual position at this point which I will unload if the stock opens higher Monday. Here's the thing about hwo. The stock is by no means overvalued but unless they win new business, the next few quarters will be flat at best...they will probably show a bit of softness. Long term though, the company should do very well given their presence in PNG. So while it's nice that hwo is finally getting some well deserved recognition, these kind of promotional surges run a high risk of being short lived if there's nothing exciting in the way of news/fundamental developments. The stock is now overbought on a daily and weekly basis which in the past led to IT tops. Given all the above, I just had to ring the register here with this spike.

At one point hwo represented 55% of my portfolio. I bought my first shares 2 years ago at $1.20. My average cost was $1.45 and I received lots of dividends along the way. Although I got partially shaken out at $2, the stock has been very good to me and the bulk of my position was sold above $3. For a company that has been producing solid, consistent results, it was often unbearably volatile. Last year at this time the stock was tanking hard for no apparent reason giving me great grief. This time around the stock has surged giving me a euphoric feeling and I so I think I'm doing the right thing fading myself here. If the stock keeps surging without me, it's obviously going to suck but as I've been saying for some time, my conviction level with hwo has declined this year and I can't be a strong holder anymore at these prices. It's important to be disciplined and not let greed (and fear) get the better of you.

I will definitely continue to keep close tabs on hwo because I still believe the company and the stock has a great LT future...I just think the risk/reward equation for the next 6-12 months makes it worth selling. I will look to redeploy the proceeds of this sale elsewhere.

Thank you Donville and others for the early Christmas gift!

Sour grapes and Sentiment

I've noticed a lot of articles lately warning about how the market is showing bubble characteristics and may be near its end. A common observation to support this view is the large inflows into equities this year and since retail is always late to the party, it signals a bull market peak is immanent. Trimtabs reported that this year has shown the largest inflows into equities since 2000 and so this must have ominous implications. I will argue that these worries are premature and it seems so many of the top callers out there have sour grapes for missing the bull market.

I clearly remember the bearishly inclined pointing out a couple years back how the market was rising without the participation of retail investors which meant that the bull market was "phony"and not sustainable. I argued just the opposite - that this was very bullish for the market given that bull markets don't end until retail has fully embraced it. Now that we are seeing retail get back into the market the doomers  argue that retail are sheep.  So, according to them it was bearish when retail wasn't participating and it's now bearish that they are! Lol! So pathetic. You know what doomers? Just shut the fuck up already and be humble for once.

Anyhow, back to the strong inflow situation. The inflows we have seen this year large as it may be,  is following 4-5 years of heavy OUTFLOWS and so this by no means suggests retail has fully embraced the bull market. It shows instead budding optimism after several years of deep pessimism. It is perfectly normal to see a bull market accompanied by optimism and hence strong inflows for years prior to its peak. That's what happened all throughout the 1990's bull market and the 2003-2007 bull market. But this has been no normal bull market.  I have often referred to the situation as bizzaro world because the wounds from 2008 cut so deep. This is why it took so long for retail to get back into the market. Are they late to the party? We will see. I suspect there are some Johnny come latelys and a shakeout is forthcoming but history shows that 1 year's worth of inflows does not suggest an immanent bull market peak, especially when there was 5 years of outflows prior to it.

Assessing sentiment is more of art than a science. You have what I like to call "ST sentiment" which is relevant to the outlook for the next 1-4 months  and "LT sentiment" which is relevant to the LT trend of the market i.e. whether it's in bull or bear mode.  A good way to think about it is like this: ST sentiment is the equivalent to the position of the earth's daily rotation and LT sentiment is like the position of the earth's orbit around the sun. Indicators I often mention such as AAII sentiment and weekly fund flows are ST sentiment indicators. Often times I see people incorrectly using these type of ST sentiment indicators to gauge the LT condition of the market. Currently the ST sentiment indicators which includes the recent surge in inflow the doomers are griping about is signaling there is over-exuberance that makes the market vulnerable in the ST but not the LT. And like I said last post, it's possible for a market in bull mode to still make significant headway when ST sentiment is redlining like this (but when the correction does come it wipes out all those gains made) which is why timing ST tops in bull markets is often very difficult.

The following chart is what I believe, an accurate picture of what LT sentiment looks like right now. It shows investor's  "risk appetite". I love this indicator not only because of its great track record and that it's under the radar, but also because it takes into account 46 economic inputs.

As you can see, we are just edging into the risk seeking  phase i.e. optimism phase of the bull market. As you can also see, in prior bull markets, risk appetite was well in the risk seeking part of the chart for years until the bull market peaked which at that point investors became risk loving (greedy) along with a tight money (inverted yield curve) situation -  the lethal combination that kills bull markets.

There are some pockets of froth out there such as some of the internet and social media stocks but overall, the above chart shows we are still comfortably far from the point where investors are greedy on a  LT basis. This is also confirmed by the anecdotes I always mention. What's also notable about this chart is how extremely risk adverse investors were at the nadir of the financial crisis. It shows that went through a once in a century type storm and we are simply just starting to normalize.  But I must warn as I always do that these types of indicators are not ST market timing tools. I would have (and did)  made the same LT bullish case in mid 2011 just prior to the 20% drop in the market.