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Macro vs micro


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I typically hold a majority of small illiquid companies in my portfolio and that is because they appear the cheapest or offering the highest retun possible in what could be found in the stock market. Generally, I am close to fully invested.

 

2008 has tought me that macro matters and can destroy what looks like terrific value at the micro level. You can do the best analysis in the world, know all about reading balance sheets and income statements, but if things get really bad in the economy, what looks like a sound company can end up BK. Deciding to go to cash in early 08 was also a macro call and meant to purposely ignore value investing opportunities.

 

It appears that we could be getting back into this mode again: a double dip recession or worst. The recovery could also continue, but the key is that no one knows. What I hold currently appears to me terrific, but it won't look as terrific if earnings collapse or if the market offers again the kind of valuations seen in late 08/early 09.

 

To be clear, I understand that volatility of the stock market is one thing, but the macro impact of something like a depression on your holdings cannot be dismissed. Think of the impact on something like SFK for example.

 

If you are in a similar situation as mine, what are you doing now to hedge the unknown? A possible abyss just months away?

 

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Just last night, I posted a Seth Klarman quote that is probably appropriate, "Choose your remorse." A certain percentage of my portfolio is very sensitive to the economy; they will do fine at ~0-1% real GDP growth, but they will trip over an inflection point if there is another major macro shock. However, I've right-sized my portfolio to compensate for that quality. I think the extreme conditions Klarman fears may occur, but I would rather add to my companies with powerhouse balance sheets and macro resistant business models than try to directly hedge a scenario. Unlike a pro money manager, I can adjust my return expectations and focus instead on purchasing at levels that promise some positive real return.

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Don't fall in love, take gains off the table, limit the unrealized gain to X%, increase the position hedges to 50%+, move up the quality curve into marginable securities, increase liquidity to minimum 50%.

 

Recognize that insurance costs; commission & opportunity costs rise, but liquidity rises & volatility declines. The more uncertain the environment, the higher the cost.

 

Recognize that the strategy change over time; when times are hard one plays defensively with a few breakouts here & there, & reinvests in quality at cheap prices for the long term.

 

Recognize that liquidity is cash + unused borrow capacity; cash is best, then securities that are 70-90% marginable, small caps < $3 are worst. Move up the quality curve & liquidity can improve dramatically, with no impact on cash.

 

SD

 

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I read an interview which said, A lot of my value investing friends think the world will fall apart but are fully invested. I tend to fall into that camp, but I have 20% cash.

 

I have been calling for a pullback since $8k, I have learned you have to think for yourself on these things, ignore the crowd and look at the facts. If you are smart and your analysis is sound it should work out. If you cant do that then the next best thing is to simply be contarian.

 

I fall into the later category. I don't think things are as bad as is believed now, but didn't think the market / economy had roared back like everyone thought a few months ago. I see this as another opportunity to reload, and my basic philosophy is this too shall pass.

 

The market is overvalued and needs to come down. People much smarter than myself have done the analysis and said so (Grantham, Watsa, Many Others). Also the stocks we tend to like SFK, ATSG, SSW, FFH, LRE are fairly cheap, but will get cheaper with everything else. Time to reload. If the world goes to hell and a hand basket for the long term, then it doesnt really matter much anyway.

 

Macro wise the only thing that really worries me is interest rates of 10% +. Its tough and I dont have any experience investing in that area. Some say its 3 years away, some say never, some say around the corner. I plan to stay in at least until I have a better understanding of what those rates do to businesses and investments.

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Cardboard, in times like these (when stocks have had a great run) I think about Buffett's rule #1 = don't lose what you have. Over the years, I likely have been WAY too cautious. Yes, I have missed lots of potential gains. However, I also have missed pretty much every major sell off since the mid 90's. My portfolio has compounded at just over 20% per year.

 

Currently, I do not like risk/reward trade off. Stocks and risk assets have had a simply amazing run. However, the amount of debt out there, which is causing the problems, is not really going down (simply shifting from the private sector to the public). Economic growth is low. Unemplyment is crazy high (in the US). I have ordered the Reinhart/Rogoff book (It's Different This Time)... my understanding is they say that history teaches that debt binges always end ugly and take many years (not 18 months) to be rectified. Bottom line is history has taught me there are times when it pays to be in cash. As I said in an earlier post, I am currently 93% cash and 7% equity (one position - GVC). If I am wrong (and risk continues in a bull market) I will have to be happy with a 5% return this year. If I am right (and we get a strong market correction in the mext 6 months) I will be in the perfect position to buy low...  I also find it instructive to see FFH selling as material amount of equities and maintaining a 30% hedge (in Q1); who knows what they are doing in Q2 but my guess is they are likely net sellers of risk assets.    

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I fully agree with Viking here. I am raising as much cash a possible. I always refused to base investment decisions on macro appreciations of market and economic risks but everything is relative: this is one of those times where I do not see how things can muddle through calmly. There is no way European countries can avoid to go down one way or the other: they are competitive, they are still thinking the old way and they have accumulated so many crippling socialistic rules. I am actually worried about the "strongest" economies of Europe: France and Germany for knowing them from the inside. What happens if they look much weaker in a few months from now (I think they will)?

Japan is even worse. US and UK are facing a tsunami of debt. China looks bubblicious. Governments are manipulating the system left and right.

I am in search of good hedges however: cash for deflation, but what about inflation... I am looking. Prem, Seth and others gave me some hints.

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Cardboard, in times like these (when stocks have had a great run) I think about Buffett's rule #1 = don't lose what you have. Over the years, I likely have been WAY too cautious. Yes, I have missed lots of potential gains. However, I also have missed pretty much every major sell off since the mid 90's. My portfolio has compounded at just over 20% per year.

 

Currently, I do not like risk/reward trade off. Stocks and risk assets have had a simply amazing run. However, the amount of debt out there, which is causing the problems, is not really going down (simply shifting from the private sector to the public). Economic growth is low. Unemplyment is crazy high (in the US). I have ordered the Reinhart/Rogoff book (It's Different This Time)... my understanding is they say that history teaches that debt binges always end ugly and take many years (not 18 months) to be rectified. Bottom line is history has taught me there are times when it pays to be in cash. As I said in an earlier post, I am currently 93% cash and 7% equity (one position - GVC). If I am wrong (and risk continues in a bull market) I will have to be happy with a 5% return this year. If I am right (and we get a strong market correction in the mext 6 months) I will be in the perfect position to buy low...  I also find it instructive to see FFH selling as material amount of equities and maintaining a 30% hedge (in Q1); who knows what they are doing in Q2 but my guess is they are likely net sellers of risk assets.    

 

viking,

 

May I ask what instrument you are using to hold your cash?

How do you figure you can get a 5% return this year with 93% in cash (continued bull market scenario)?

 

Interesting thread, thanks all!

 

 

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nonub, my previous post was not very clear... by selling the equities I held in my portfolio I was able to realize a 5% return on my total portfolio for YTD 2010. With 93% in cash, my return over the final 7 months of the year may be tiny, which I am just fine with; with my cash I park it only in cashable GIC's (CDIC insured) as I am not after return but rather something safe.

 

It makes me laugh when I hear 'you have to put your cash to work'. All this approach does is put pressure on the holder of cash to buy some risk asset. Rather, people should be told to 'put their cash to work when quality is dirt cheap'... if not, holding cash is the most intelligent thing to do (even for a year or longer)!

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Keep in mind that;

 

You need to do better than your next best benchmark. For most folks here that is probably a 100% investment in FFH; hedged (sold) down to 50% over the higher risk summer months. Add in their 15% ROE, & the typical seasonal variation in the BV multiple, & you get around 20%. Not risk free, but not especially risky either.

 

Very few of us here are going to do 20%+ as reliably, every year, with as little volatility, in all kinds of conditions. We might do better when markets are buoyant, ... but when they aren't? At times its just better to invest with HW, rather than alongside.

 

Before they found this board, most common sensical laypeople might have averaged maybe a 6%/yr average return when the 5 yr Canada was around 3%; or about the 5yr Canada rate + inflation + GDP growth. If FFH is your benchmark; today your spread is maybe 17% (20-3), or > 5x what it was. Do you really need the additional risk?

 

SD

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I have been very attuned to macro since I suffered some heavy losses owning companies that weren't able to survive the credit crunch.  These were pre-value investing positions that I held until they went under.

 

That made me realize that Berkowitz's "kill the company" test is very important, and that test must involve assessing the macro situation.  To ignore macro factors is to ignore reality.

 

Rather than hedging per se, I find myself moving into more high quality stocks that will survive dire macroeconomic outcomes, a la Jeremy Grantham, and holding more cash.  Some of the stocks I own are also "growth stocks" a la Phil Fisher, although I'm really using a mix of Phil Fisher and Buffett in picking these types of companies.

 

I also bought a little bit of gold as an experiment to see how it will perform in case of a panic or sustained downturn.

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1. I take "ignore macro" guidance as essentially not trying to use macro factors (interest rates, growth rates, currency changes, etc) to form specific opinions on the direction of the stock market. I do not think "ignore macro" ever meant ignoring macro variables in valuing and evaluating securities (can the business survive high inflation, can be business prosper if there is a sharp drop in economy, can the business earn decent return on invested capital due to the likley foreign competition, etc).

 

2. This also resonates with what Grantham is saying recently about value investors. Many value investors, including people like Pabrai are essentially investing in stocks ignoring the risks on far left tail. They just seem to assume that things would not really get too bad. Most of the time they seem to assume that things would not get too bad. So their investment strategies would most likely get good returns as long as we do not have a Great Depression type scenario or something close to that. But if such a scenario does occur, they would suffer very large permanent loss of capital. Many of the smallest stocks with high debt loads or highly cyclical businesses would not survive a 1 in 50 year event. Yet this is precisely the area where several deep value investors seem to invest a large portion of their portfolios. This seems to me to be quite different from the types of securities that Graham (via requring very very stringent criteria as evidenced by his emphasis on earnings/survivability "under depression conditions") and Buffett have invested in (See's, GEICO, Coke, Washington Post, Gillette preferred, Amex, Wells Fargo, General Dynamics, Boeing, etc).

 

I respect Pabrai and posters on this board a lot but just could not reconcile this seeming obliviousness to far left tail risks. 

 

Thanks

 

Vinod

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I'm about 17% cash in my investments accounts and I don't expect it to raise through selling of securities unless they reach their intrinsic values. I'm a net buyer of securities since I'm always adding cash from my investments. I have bough very little securities in the last 4 months tough so cash is slowly increasing.

 

What I have figured out while reading this post is that about 40-50% part of my portfolio is not directly related to an economy recovery but rather past and future stable cash flows. For the last year I've been investing with the mind that we will probably have 0-1% growth rate for the next 5 year. For example here is my portfolio:

 

FFH 13% (Insurer, somewhat linked to the economy but more linked to outside events)

Brk 6%   (50% Insurer and 50% Economy related)

RCH.TO 20% (Distributor of hardware equipment, fully linked to economy, but no debt, lot of cash and awesome and honest management, won't sell unless it reaches much more then IV)

EH.TO 23% (Rent to own operator, moderately linked to the economy their customer base is much less prone to cut spending. Great new EasyFinancial division will generate huge interest revenues but will not require CapEx)

XDM.TO 8% (Organizes Not for profit events, not linked to the economy)

XIC 13% (I keep this one for my portfolio diversification, it's going down as the portfolio grows)

 

I agree macro matters but instead of selling my stocks and raising cash I have been trying to insulate part of my portfolio to the economy swings.

 

I'm ready to accept the fact that when the earth trembles the correlation between asset classes is 1.

 

BeerBaron

 

 

 

 

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I am also heavily in cash it is not so much a macro call as a micro one ,not too much appeared extremely cheap and one month ago at least as measured by the VIX which i bought the mkt over-all seemed quite bubbly. I sold my Vix position the Friday before the European bail-out was announced and have been picking away at European equities particularly ING ever since. But just nibbling. One general observation on macro issues if we are building a society were no-one loses then if we use the example of the Japanese experience do we not have the end result of no body wins either.

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I wish I had a statistic that could tell me what % of cash & % margin people where putting on their portfolios. I can't tell if we are the smart ones, going into cash or are we the Mr. Market and lots of people are going into cash, which is one of the reasons there is still value.

 

Currently (1) I carry more cash at the moment and raising cash also...but might be buying soon as well. (2) I'm looking for copper companies to short - looking for expensive ones that sell to china - which has an obvious housing bubble if not infrastructure bubble. (3) I'd like to find an inexpensive way to hedge against inflation like klarman so I think pm/kft/jnj could be an ok substitue.

 

 

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Cardboard,

 

"I typically hold a majority of small illiquid companies"

 

My first thought was, is that not the opposite of what a lot of investors do in stressful times ie look for large liquid names.

 

After thinking about it, it may be a good strategy as I noticed the 2 small illiquid holdings I have hardly move in recent panic selling

of May 6. Would be an even better strategy IMHO if they paid a dividend (are there any such animals out there?)

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Thanks guys for all the replies.

 

Looking in detail at my portfolio yesterday, I realized that I had grown quite complacent with all the good fortune since March 9, 2009. A date that I will not forget! 100% long, some leverage via options, still invested in good opportunities, but nowhere near as good as they were: overall price to value ratio going up.

 

In order to rebalance my portfolio and psychology, I think that it may be time to look for short ideas again. This was suicide in the run from the lows with all boats rising, but with the market now at least more "neutral", it should react negatively to bad companies instead of having them rising with the rest. It should also force me to really think twice before buying and on what to hold since I will also be on the lookout for what is a good short.

 

Are you short any names right now?

 

One developing trend that I see sticking for quite a while is the severe weakness in the Euro vs other currencies which will lead to smaller profits for Canadian and U.S. entreprises doing business in Europe. This may be quite a nasty development for some specific cos.

 

Cardboard

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Biaggio,

 

I didn't mean that I was specifically looking for illiquid stocks. It is just that some small companies trade very little. They are ignored by the market and it helps them be cheaper. What I also noticed is that they trade very little when you buy them, then when the good news comes out along with the price there is generally no problem selling them with volume picking up. What I am more worried about is their survival capacity under depression like conditions.

 

Regarding price movement, sometimes they look good in your account because they don't trade in a down market. Although, it is an illusion since if you were trying to sell them at that point, you would likely find very low bids making it worse than the market decline in %. With time, the bid/ask will generally follow the market on the downside.

 

Cardboard

 

 

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After thinking about it, it may be a good strategy as I noticed the 2 small illiquid holdings I have hardly move in recent panic selling

Microcap performance from late 2007-2009 was horrible. I had RLOG and ITEX which at one stage lost over 75% of their value despite the businesses being fine.

 

I think the reason why they haven't declined too much as of late has simply been because they were so completely oversold in March 2009.

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A little too raw for our tastes but if you're nimble - look at NBG (TSX)

 

We dont think the Euro will collapse; but everytime a 'fix' goes in this thing jumps $.40-$.50, then falls back on coverage of the increasing street protests. Hard to see how it cannot trend down a lot lower over the next 6 months or so.

 

SD

 

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David Rosenberg on deflation -- http://www.zerohedge.com/article/rosenberg-pig-farmers-placing-short-bets-now-we-retest-sp-900

 

Krugman on potential lost decade -- http://www.nytimes.com/2010/05/21/opinion/21krugman.html?src=me&ref=general

 

Mohammed El-Erian says both Europe and the US face deflationary risks.

 

Wilbur Ross sees stagflation in Europe.

 

We all know what Richard Koo thinks.

 

Choose your investments wisely!

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