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Time For Capital Preservation?


Viking
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Sorry for the updates to this post; my thumb posted it before i was done with my thoughts :-)

 

Since February of 2018 the financial markets have been steadily weakening.

 

However, i have been focussed on the strength of the US economy. All of the leading indicators were not even on recession watch. So i remained 100% invested, heavily skewed to US banks. I was also focussed on 10 year US treasuries, which peaked out at 3.3%, which supported the idea that the US economy was doing well.

 

The economic data coming out of the US recently looks to be to be now flashing yellow (no recession imminent but things are trending in the wrong direction).

- ISM Manufacturing Index Decreases Sharply to 54 in December: https://www.calculatedriskblog.com/2019/01/ism-manufacturing-index-decreased.html

 

The 10 year US bond is now trading at 2.57%, which is not healthy.

 

The bottom line is it looks like the US economy has turned (growth slowing) and the data coming out will now show declining numbers with risk to the downside.

 

Weakness in China looks to be getting worse: https://www.theguardian.com/business/2019/jan/02/stock-markets-dive-china-manufacturing-contracts-ftse-wall-street-us-economy-business-bleak-start-to-2019

 

Europe is not great. Italy is a mess. The UK is a mess.

 

Trade wars add to the complexity (and the risks).

 

Politically, populism is just getting started; as economies slow and enter recession it makes sense to me workers will not be so patient. Politicians will fan the flames to get reelected. Nationalism will be a natural outcome. The 1930’s can perhaps provide some insight.

 

In Washington we have a President that i have little confidence in (to be able to handle a crisis in the proper way). This simply increases the risk of a bad situation getting worse.

 

Bottom line, i have been increasing my cash weighting. Capital preservation is more important to me in the current environment than return.

 

I guess what i am really asking is can things get worse from here? Is this the bottom? Or are we only in the early innings of this 9 inning game? My read is we are perhaps only 33% of the way though this current weakness in financial markets (with another year or two of turbulence ahead).

 

PS: Gundlach does his annual forecast presentation on Jan 8 and he will be going over all the US data. https://doubleline.com/latest-webcasts/

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I think there is quite a bit baked in right now, but don't disagree that there could be rough patches. That said I don't think today is worth getting worked up over. People bid up a challenged company because Buffett bought it and paid the price. Just because lower and middle class people stopped seeing the need to give Apple $700-$1000 a year for the same phone with a new color or extra inch of screen space, doesn't mean the economy is slowing down. In fact, it might mean people are getting smarter or spending that money elsewhere...

 

Although, it does seem this is all pointing the data in a direction that will give the Fed pause, and may even lead to revisions in terms of their previously hawkish stances.

 

 

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I don't know. I think times are pretty good. Better than in a long time. Sure you're not just putting too much emphasis on recent data? I mean, when was Italy not a mess? And who cares about the UK? I think it's a futile game. Why even bother when you can buy good businesses with plus 10% FCF yields and treasuries are at 2,5%? If shit hits most good companies emerge stronger from a crisis - hopefully with less shares outstanding. I'm all in. 8) (famous last words?)

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I spent my early career at a too-big-to-fail bank when the stock went from $50 to $1.  I saw a lot of long faces and I started going to Omaha in early 2009.  It was a great experience to go through and it taught me that 1) You never want to be forced out of the investment game. I saw too many people lever up and got the house/farm/business taken away. 2) It was great to learn how not to blow up, but it probably made me a bit too bearish as well.  3) I am starting to realize that let the ideas guide you.  What I mean is that if you find it easy to find doubles and triples in good companies with good balance sheet, buy them.  If you find yourself buying into crappy companies with bad balance sheet and no moat and you're underwriting it at a high single digit IRR, it's probably better to sit on the side line.  Buying something at 25-30x P/E for a good company with less than 10% growth is probably not a sound value strategy.  Keep some cash.  If you start finding high quality doubles as easy as shooting fish in a barrel, it's time to pull the trigger. 

 

If you invest in companies where you know the CEO will buy back stock in a  crisis from the operating cashflow, even better! 

 

Given all that I have said, I think that the market is down high teens from its peak already.  It's a decent starting point.  We are certainly not at the point of capitulation where everyone is scared and thinks that nothing will be worth anything.     

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Bottom line, i have been increasing my cash weighting. Capital preservation is more important to me in the current environment than return.

 

I guess what i am really asking is can things get worse from here? Is this the bottom? Or are we only in the early innings of this 9 inning game? My read is we are perhaps only 33% of the way though this current weakness in financial markets (with another year or two of turbulence ahead).

 

Given all that I have said, I think that the market is down high teens from its peak already.  It's a decent starting point.  We are certainly not at the point of capitulation where everyone is scared and thinks that nothing will be worth anything.     

 

This is my view too. Two days ago the front-page headline in a local paper (in Norway) read "2019 will be a great year". The financial papers write about the  market decline, with some "experts" saying it's a great time to buy, others that things will get worse. For the most part, it seems "main street" is not (yet?) giving this much thought.

 

I tell myself not to try to call the bottom, but I do think the most probable scenario is that things will still get worse. When the local newspaper declares that the future is bleak, I will hopefully have accumulated a bit of cash. I am still mostly invested btw, just a bit less than before.

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I spent my early career at a too-big-to-fail bank when the stock went from $50 to $1.  I saw a lot of long faces and I started going to Omaha in early 2009.  It was a great experience to go through and it taught me that 1) You never want to be forced out of the investment game. I saw too many people lever up and got the house/farm/business taken away. 2) It was great to learn how not to blow up, but it probably made me a bit too bearish as well.  3) I am starting to realize that let the ideas guide you.  What I mean is that if you find it easy to find doubles and triples in good companies with good balance sheet, buy them.  If you find yourself buying into crappy companies with bad balance sheet and no moat and you're underwriting it at a high single digit IRR, it's probably better to sit on the side line.  Buying something at 25-30x P/E for a good company with less than 10% growth is probably not a sound value strategy.  Keep some cash.  If you start finding high quality doubles as easy as shooting fish in a barrel, it's time to pull the trigger. 

 

If you invest in companies where you know the CEO will buy back stock in a  crisis from the operating cashflow, even better! 

 

Given all that I have said, I think that the market is down high teens from its peak already.  It's a decent starting point.  We are certainly not at the point of capitulation where everyone is scared and thinks that nothing will be worth anything.   

 

I am guessing that was the bank where the CEO felt he needed to dance as long as the music keeps playing. One real lesson from 2009 is that you never want to be in a situation where you needn’t dilute at the bottom. This is what killed many Bank stocks, even those those that survived. It’s sometimes that little extra buffer on the balance sheet that doesn’t matter in good times that can make all the difference in bad times.

 

I never worked in banks, but  have been with companies where management destroyed a lot of value (99% from top to bottom in one case and 70% in another) and they still made out very well. Quite amazing how incentives are stacked.

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I read Peter Lynch's book when I started investing.  He says over and over, don't time the market.

 

Every book I have read on Buffet says don't time the market.

 

Why are we doing this here?  Why not just find high quality companies and eat it.  If you are living off your funds I guess it is different but then I would have a bond buffer regardless.

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Couple of observations ...

 

The financial press is paid to 'set' storylines for the masses .... but do any kind of a 'back-test' on the accuracy of those predictions?

Almost always, the better outcome is a bet against the prevailing story of the day.

 

'Storylines' are time-sensitive, meaning days - not weeks, or months. A story-line that persists over any length of time, has to be 'pushed' by someone - either 'unwinding', or building a book of business for later disposition. Selling against the storyline, puts you in good company.

 

Size matters. Stay small and you cost more to remove than you are worth.

It's just the cost of doing business.

 

Then look around you ...

 

Trump didn't achieve much when he had control of the US Senate; why do you think he'll do better now, when he no longer has that control? Trump creates 'crisis' and 'distraction' to enable a deal - but to get 'deals' done he needs movement; no movement, and sharks drown.

 

Trump remains implicated in a criminal organization, and all the 'distraction' in the world, doesn't change that. We know the man is thin-skinned, and how long can it really be before Senate controlled investigations start to seriously cook the frog - 6 months, maybe 1 year? And if the 'wall' gets stymied, Iranian sanctions prove ineffective, and the 'rate' at which US troops return 'home' significantly slows?

 

Isn't the smarter bet against the press stories, and in favour of greater Trump distraction?

 

SD

 

 

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Couple of observations ...

 

The financial press is paid to 'set' storylines for the masses .... but do any kind of a 'back-test' on the accuracy of those predictions?

Almost always, the better outcome is a bet against the prevailing story of the day.

 

'Storylines' are time-sensitive, meaning days - not weeks, or months. A story-line that persists over any length of time, has to be 'pushed' by someone - either 'unwinding', or building a book of business for later disposition. Selling against the storyline, puts you in good company.

 

Size matters. Stay small and you cost more to remove than you are worth.

It's just the cost of doing business.

 

Then look around you ...

 

Trump didn't achieve much when he had control of the US Senate; why do you think he'll do better now, when he no longer has that control? Trump creates 'crisis' and 'distraction' to enable a deal - but to get 'deals' done he needs movement; no movement, and sharks drown.

 

Trump remains implicated in a criminal organization, and all the 'distraction' in the world, doesn't change that. We know the man is thin-skinned, and how long can it really be before Senate controlled investigations start to seriously cook the frog - 6 months, maybe 1 year? And if the 'wall' gets stymied, Iranian sanctions prove ineffective, and the 'rate' at which US troops return 'home' significantly slows?

 

Isn't the smarter bet against the press stories, and in favour of greater Trump distraction?

 

SD

 

Honestly, I have no idea how to interpret the Trump story and how it affects my investing strategy.  I just looked at the NAV/Price of my portfolio and took the puts that went up 10x recently and increased what I considered to be my most undervalued/longest runway idea and increased the allocation by 65%.  I think I can sleep on that idea for the next 2-10 years.  I am literally not smart enough to interpret Trump. 

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Couple of observations ...

 

The financial press is paid to 'set' storylines for the masses .... but do any kind of a 'back-test' on the accuracy of those predictions?

Almost always, the better outcome is a bet against the prevailing story of the day.

 

'Storylines' are time-sensitive, meaning days - not weeks, or months. A story-line that persists over any length of time, has to be 'pushed' by someone - either 'unwinding', or building a book of business for later disposition. Selling against the storyline, puts you in good company.

 

Size matters. Stay small and you cost more to remove than you are worth.

It's just the cost of doing business.

 

Then look around you ...

 

Trump didn't achieve much when he had control of the US Senate; why do you think he'll do better now, when he no longer has that control? Trump creates 'crisis' and 'distraction' to enable a deal - but to get 'deals' done he needs movement; no movement, and sharks drown.

 

Trump remains implicated in a criminal organization, and all the 'distraction' in the world, doesn't change that. We know the man is thin-skinned, and how long can it really be before Senate controlled investigations start to seriously cook the frog - 6 months, maybe 1 year? And if the 'wall' gets stymied, Iranian sanctions prove ineffective, and the 'rate' at which US troops return 'home' significantly slows?

 

Isn't the smarter bet against the press stories, and in favour of greater Trump distraction?

 

SD

 

Other than Trump being a wildcard, I see no connection to any investing strategy.

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The only investment strategy I know is buy when you find a compelling bargain. If you don't find it, don't buy it.

 

Or as Will Rogers said: "Don't gamble; take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don't go up, don't buy it."

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Trade volatilty. Sell into the immediate story, and buy back 1-2 months later.

If the financial press is positive (trend in prices, growth, etc.) sell down; and buy back when the first 'negative' appears - same as the market maker. Trump is just the loudest reliably 'disuptive' voice creating that volatility.

 

Rattle Trumps base, and sell into the resultant xenophobia.

Rinse and repeat ;)

 

SD

 

 

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Isn't the smarter bet against the press stories, and in favour of greater Trump distraction?

 

SD

I don't know if this was a reference to my post (the headline "2019 will be a great year" etc), but just to be clear: What I meant was that the more negative the stories get, the more confident I will be of positive future returns. And right now I see a mix of positive and negative stories. Not much "blood in the streets".

 

I read Peter Lynch's book when I started investing.  He says over and over, don't time the market.

 

Every book I have read on Buffet says don't time the market.

 

Why are we doing this here?  Why not just find high quality companies and eat it.  If you are living off your funds I guess it is different but then I would have a bond buffer regardless.

 

Buffet also says "Buy when there's blood in the streets". My view (on ignoring the market) changed a bit after reading Howard Marks "Mastering the market cycle". There is a big difference between trying to time the market, and having a general opinion on where we are in the market cycle.

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I read Peter Lynch's book when I started investing.  He says over and over, don't time the market.

 

Every book I have read on Buffet says don't time the market.

 

Why are we doing this here?  Why not just find high quality companies and eat it.  If you are living off your funds I guess it is different but then I would have a bond buffer regardless.

This. I don't understand why one needs to know much more than that. I think a personal investor has a big advantage because one can ignore short term thinking and accept volatility as a gift and opportunity, while it's a real (job) risk for PM's. But I really don't think any smalltime investors have an advantage in interpreting PMI data out of ChIna and what have you, so when even pro's seem to get it wrong more often than right, why even try? The odds look really bad.

 

As for buying when there's blood in the streets - there's always a bloody street somewhere. I mean, even mega caps often swing 40 pct from top to bottom during the year, so surely there is opportunies (now I'm not saying they're easy).

 

As for Howard Marks, I think he's pretty wise. What I've taken away from him is that playing leveraged small cap probably isn't the best time right now, but as always it depends on price.

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I read Peter Lynch's book when I started investing.  He says over and over, don't time the market.

 

Every book I have read on Buffet says don't time the market.

 

Why are we doing this here?  Why not just find high quality companies and eat it.  If you are living off your funds I guess it is different but then I would have a bond buffer regardless.

 

No-free-lunch, i agree with your comments about Lynch and Buffett. I think the overlay is every investors situation is different and they therefore need to modify the teachings of the masters to fit their personal situation so it is a good fit.

 

Canadian author David Chilton also says that wherever strategy you employ, it must allow you to sleep well at night.

 

Lynch also says that you should own cyclicals at the start of an economic cycle, not the end.

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I generally agree with others on the difficulties of timing the market.  FWIW, I’ve been buying recently (individual stocks only though; I’m still not particularly bullish on the S&P). 

 

Another thing to note is that if you’re worried about macro, you might also want to take into account the risk of inflation.  It’s been low for a while but it’s rising, and it could go up even more if, for instance, Trump somehow forces the Fed to loosen up.  And in an inflationary environment, cash will not protect your capital (unless short term interest rates somehow rise enough to offset it). 

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Viking,

 

Thank you very much for keeping us in loop with regard to updates on relevant US macro stuff [macro stuff, that matters, by the way!]. I have now put it [the Gundlach presentation] in my calendar, so that I don't miss it, and I'm looking forward to that. [ : - ) ]

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Market timing is tough, but both Howard Marks and even Graham to some extend thought about the market in a broad context. Howard Marks reminds us where we are likely within a cycle and Graham suggested to put a higher percentage of a capital into bonds when the market was high and bargains were few, as far as I remember.

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Trade volatilty. Sell into the immediate story, and buy back 1-2 months later.

If the financial press is positive (trend in prices, growth, etc.) sell down; and buy back when the first 'negative' appears - same as the market maker. Trump is just the loudest reliably 'disuptive' voice creating that volatility.

 

Rattle Trumps base, and sell into the resultant xenophobia.

Rinse and repeat ;)

 

SD

 

Illustrative of what we can perhaps expect ....

https://ca.reuters.com/article/topNews/idCAKCN1OY0D3-OCATP

 

“Yes, I have. And I can do it if I want,” Trump said. “We can call a national emergency because of the security of our country ... I may do it. But we can call a national emergency and build it very quickly.” Emergency powers have been invoked by previous U.S. presidents during times of war.

 

Senate Democratic Leader Chuck Schumer said Democrats had told Trump during the meeting to end the shutdown. “He resisted,” Schumer said. “In fact, he said he’d keep the government closed for a very long period of time, months or even years.”

 

The source also said Trump brought up recent impeachment threats during those remarks, arguing that he had notched a strong performance as president and should not be a target for impeachment. The president later told reporters that Nancy Pelosi, the new Democratic speaker of the House of Representatives, said Democrats were not looking to impeach him.

 

 

So ... we have a president who thinks he is in a 'war'; and is of the view that it's OK to 'fratenize' with the criminal element - so long as it results in ongoing 'strong performance'. And who apparently can no longer distinguish over the 'war' he is in over potential impeachment - and the USA which is currently not 'at war' with anybody. Escalating ongoing disruption ...

 

And the investment opportunity? ....

Options on the equipment and material suppliers that would be used to build 'the wall', and the closer their geography to the border - the better (bulk building material is heavy to move). As long as POTUS doesn't sprain his 'tweat' fingers, we should all be deep in the money!

 

SD

 

 

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