Natural Gas Prices Have Exploded Higher Signaling The End Of An Era

(Travis’s Note:  This article was originally authored on November 10th, 2018, and I am posting it here for the archives).

  • Natural gas prices have been in a nearly decade long bear market.
  • Natural gas equities have fared even worse.
  • Lower for longer was the prevailing mantra, but the nearly universal believe in lower for longer has potentially brought its demise.

Natural gas prices (UNG) had an incredible week, surging 13.3% to new multi-year highs, already eclipsing their 2017/2018 winter peak levels.

What is behind this surge in natural gas prices?

Simply put, structural demand drivers that were created by the universal belief in lower natural gas prices for longer have caused demand to exceed supply.

This has manifested itself in a natural gas inventory level that is below the five-year minimum.

Working Gas in Underground Storage Compared with Five-Year Range

Natural gas bears have blamed the recent favorable weather for the price action in natural gas, but these same bears, who estimate that weather has drawn down inventories by an additional 300-500 BCF during calendar 2018, conveniently forget that the historically warm winters of 2015/2016 & 2016/2017 torpedoed a burgeoning bull market in natural gas, and natural gas equities, when there was a structural supply/demand deficit, by adding roughly 2,000 BCF in unused supply to storage across the two historically warm, back-to-back winters.

The pendulum swings both ways, though, and one extreme is about to lead to another, and everything that you think you know about natural gas is going to be challenged, absent another historically warm winter.

The nearly decade long bear market in natural gas prices has created a potentially very profitable opportunity in a select group of natural gas producers, which despite residing in perhaps the most prolific energy basin in the United States, and having more favorable fundamentals than their richly valued Permian cousins, remains undervalued and under-owned.

We have been evaluating this opportunity for several years at The Contrarian, with a series of exclusive articles.  Here is a sampling of these articles, just the headlines.

Natural Gas Bullish Thesis Continues To Play Out – 11/9/2018 Update

Natural Gas Bullish Thesis Continues To Play Out – 9/21/2018 Update

Natural Gas Bullish Thesis Continues To Play Out – 7/22/2018 Update

Natural Gas Has A Supply Problem – Part III – May 16th, 2018 Update

Natural Gas Has A Supply Problem – Part II – March 7th, 2018 Update

Natural Gas Has A Supply Problem – Part I – August 6th, 2017 Update

Appalachia Natural Gas Producer Valuations – March 10th, 2018 Update

Top Idea – A Diamond In The Rough – Southwestern Energy – May 21st, 2018 Deep-Dive Research Paper

To read these exclusive member articles, please consider a subscription to The Contrarian, where we now have a free two-week trial open.

I am biased, of course, but I think we have the best group of investors and traders anywhere, seasoned by nearly three years of experience together, positive and negative, and commentary for some members, with many members actively contributing their unique perspectives to a robust Live Chat discussion on a daily basis, particularly when volatility surfaces.

We are always looking for new members that can add profitable ideas, or challenge existing ones.

From my perspective, as I said in my blog posts the past three weeks, it would be worth taking a look, simply to view the Live Chat dialogue.

I do recognize that the price point of The Contrarian is a little steep, coming in as one of the more expensive services in SA’s Marketplace.

Over the years, I have had quite a few requests for a lower-priced, more streamlined research product, and over the last several months, I have slowly put together a more traditional research newsletter.

To celebrate this official soft launch, which includes a deep-dive research report on what I believe is an extremely timely equity (delivered via email upon membership), I am offering a limited time $299 annual membership for the first 100 members. To get this discounted price, simply use the coupon code “first100”. (WTK’s Note: There are a few slots left remaining at this introductory price).

Ultimately, I think we are now at a major inflection point in the financial markets, highlighted by the price action in October of 2018, which has been ongoing in slow motion for three years, but which could suddenly accelerate. Being different, being contrarian, has been extremely painful for a long time now, however, resilience and persistence, two necessary qualities for success in contrarian investing and in life in general, in my opinion, are leading to what I believe is an upcoming golden age for active investors.

If you have any questions, send me a direct message at any time,

William “Travis” Koldus

Disclosure: I am/we are long the companies in the contrarian portfolios.

Additional disclosure: Every investor’s situation is different. Positions can change at any time without warning. Please do your own due diligence and consult with your financial advisor, if you have one, before making any investment decisions. The author is not acting in an investment adviser capacity. The author’s opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies’ SEC filings. Any opinions or estimates constitute the author’s best judgment as of the date of publication, and are subject to change without notice.

Inflection Point & Opportunity

  • Growth investing has dominated value investing for the past decade.
  • The pendulum has swung to a rarely reached extreme.
  • As it swings back the other way, which I believe it has started to do with the price action in October, there should be significant opportunity.

There is an old saying that a picture says a thousand words, so with that in mind, take a look at these two charts, the first from Ned Davis Research, and the second from Chuck Mikolajczak, by way of  Alastair Williamson.

Looking at the charts, two conclusions should be abundantly clear.

1.  The U.S. equity market has been in a bubble, and this bubble has exceeded the epic 1999/early 2000 peak valuations in certain areas.

2.  Growth companies, led by the infamous quintet of Facebook (FB), Amazon (AMZN), Apple (AAPL), Netflix (NFLX), and Alphabet (GOOGL), and carried along by many others, including NVIDIA (NVDA), and more recently, before its even more recent decline, Advanced Micro Devices (AMD), have been in-favor to the extreme excesses of the late 1990’s, while value stocks have rarely been this out-of-favor historically, on a relative basis.

The price action in October was a wake-up call, with AMZN, perhaps the leading flag carrier for the markets broader price action the past decade, down -20.2%, and cast aside, forgotten companies like Southwestern Energy (SWN), which is one of my favorite buy-and-hold investments today for the  next decade, up 4.5% for the month, even with the S&P 500 Index (SPY), which is dominated by the large-cap technology growth stocks, down -6.9% for the month.

In an irony of ironies, Southwestern Energy was actually the worst performing S&P 500 Index component from the U.S. equity bull market starting point of March 9th, 2009, through its exclusion from the venerable index in 2017, due to its lower market capitalization, which was caused by its share price decline and severe under-performance.

I would bet almost anything, that Southwestern Energy, which has undergone a very dramatic transformation the past three years that we cover in depth in The Contrarian, outperforms the S&P 500 Index over the next decade.

There are whole studies that cover how unpopular companies outperform, particularly those booted from popular indices like the Dow Jones Industrial Average (DIA), and that is the place to look for opportunity today, in my opinion.

After all, there is a reason that Ibbotson data, now part of Morningstar (MORN), shows small-cap value as the best performing asset class in the market over the long-term.

Sure, this has not been the case for the past decade, but as we showed above, the U.S. equity market has been in a historic bubble, and value equities have been historically out-of-favor.

For a first-look at the forgotten companies that I will be covering in-depth, and have been covering in-depth, please consider joining The Contrarian, which is my premium research service platform on Seeking Alpha.

I am biased, of course, but I think we have the best group of investors and traders anywhere, seasoned by nearly three years of experience together, positive and negative, and commentary for some members, with many members actively contributing their unique perspectives to a robust Live Chat discussion on a daily basis, particularly when volatility surfaces.

Right now, we have an open free trial at The Contrarian, so if you have ever had an interest in test driving our group, now is a good time.

From my perspective, as I said in my blog posts the past two weeks, it would be worth taking a look, simply to view the Live Chat dialogue.

I do recognize that the price point of The Contrarian is a little steep, coming in as one of the more expensive services in SA’s Marketplace.

Over the years, I have had quite a few requests for a lower-priced, more streamlined research product, and over the last several months, I have slowly put together a more traditional research newsletter.

To celebrate this official soft launch, which includes a deep-dive research report on what I believe is an extremely timely equity (delivered via email upon membership), I am offering a limited time $299 annual membershipfor the first 100 members. To get this discounted price, simply use the coupon code “first100”.  (WTK’s Note: There are a few slots left remaining at this introductory price).

Ultimately, I think we are now at a major inflection point in the financial markets, highlighted by the price action in October of 2018, which has been ongoing in slow motion for three years, but which could suddenly accelerate. Being different, being contrarian, has been extremely painful for a long time now, however, resilience and persistence, two necessary qualities for success in contrarian investing, in my opinion, are leading to what I believe is an upcoming golden age for active investors.

If you have any questions, send me a direct message at any time,

William “Travis” Koldus

Disclosure: I am/we are long SWN and short SPY as a market hedge.

Additional disclosure: Every investor’s situation is different. Positions can change at any time without warning. Please do your own due diligence and consult with your financial advisor, if you have one, before making any investment decisions. The author is not acting in an investment adviser capacity. The author’s opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies’ SEC filings. Any opinions or estimates constitute the author’s best judgment as of the date of publication, and are subject to change without notice.

An Ode To Indiana & An Introduction To The Forgotten Equities Series

  • Passive index investing has dominated fund flows for a long time, accelerating over the past decade.
  • Once vaunted value investors have been left behind, as have a whole group of out-of-favor, forgotten equities.
  • The pendulum has swung too far to one extreme, and appears to be starting its move in the other direction, offering historic opportunity for forgotten equities.

I grew up, and have spent almost all my life in the great state of Indiana, though I have traveled across the United States, and a little bit of the world (I want to travel more) in my career, and for pleasure.

Growing up in Northwest Indiana, which was really an extended connection to Chicago, referred affectionately to those from this area as “The Region” (I actually used to tell people that it was really like growing up on the South Side of Chicago, but true South Siders take offense to that), I went to college for undergrad studies at Ball State, in Muncie, Indiana, then moved to various suburbs around Indianapolis, working first in a suburb, then in downtown Indianapolis, then in a suburb again, before starting my own boutique investment research firm.

More recently, my life, which is a story on its own accord, for a book that would make interesting, perhaps even good reading, even for those not financially inclined, and my career to an extent, has taken me to various small towns across Indiana (and some of the bigger cities too…which outside of Indianapolis are really pretty small on a national scale, with the possible exception of Ft. Wayne), and even though I love geography, and enjoy driving, it is amazing to me the number of different small towns that I was unaware of, and stories behind them, which I am sure is true in a number of states, however, I have not traveled them nearly as much.

Many of these small towns, dotted in-between the never ending corn and soybean fields, which can be a beautiful backdrop driving, especially in the changing seasons, are forgotten by those in the bigger cities in Indiana, which really, again, there are not many of, let alone on a national scale.  Summarizing, I have spent virtually my whole life in Indiana, and I come across new towns and places on a regular occasion, with their own interesting backstory and history.

Building on the narrative, even though Indiana is home to a number of Fortune 500 companies, including Eli Lilly (LLY), Cummins (CMI), Steel Dynamics (STLD), Zimmer Biomet Holdings (ZBH), Berry Global Group (BERY), which honestly I had not heard of before today and I have spent my past 25 years actively research and investing, and Simon Property Group (SPG), and a number of S&P 500 Index (SPY) companies have significant operations located in Indiana, which is a list too big to show in its entirety, including somewhat surprisingly Salesforce.com (CRM), on this note Indianapolis is also a finalist for Amazon’s (AMZN) second headquarters search, and a number of global industry leading companies have significant operations in Indiana including ArcelorMittal (MT), and Roche Holding Ltd (OTCQX:RHHBY), (OTCQX:RHHBF), Indiana is an overlooked state, in my opinion, on a national profile.

Sure, we in Indiana have globally recognized institutions with significant fan followings, including Notre Dame football in South Bend, Indiana basketball in Bloomington (though they have been in a down cycle, they are still a sleeping giant with a level of national success that only a few other programs can match), heck even the much maligned NCAA headquarters is located in Indianapolis.

The college programs and towns in Indiana are terrific from Purdue in West Lafayette, to Indiana University in Bloomington, to Notre Dame in South Bend, to Butler and IUPUI, both in Indianapolis, to Indiana State in Terre Haute, and Rose-Hulman Institute of Technology in Terre Haute (Rose-Hulman, which I go to on a regular basis, and Purdue are two of the finest engineering schools in the country), and right on down through the smaller colleges such as the University of Indianapolis, DePauw University in Greencastle, Indiana, (the only time I ever ran of gas driving, which occurred recently, was near Greencastle, where a nice man, resembling a younger version of my deceased for seven year father, and having his same first name, picked me up and helped me on my way), and Wabash College in Crawfordsville, Indiana.

Speaking of my deceased father, who I wrote about more here, we used to travel the state together for a couple reasons.  First, he was an athletic director, and coached a bunch of sports, so by default their was regional and statewide traveling.  Second, we both loved Indiana high school basketball, particularly before the winner-take-all tournament was changed, and third, my dad had a love for track-and-field, which he coached at the high school level too, and followed with interest around the state.

Interestingly, the professional sports teams in Indiana, including the Indiana Pacers, which I had tickets too for some time, including when they collided with the Miami Heat team four consecutive finals team, led by LeBron James and Dwyane Wade, and the Indianapolis Colts, probably have less state and national followings that Notre Dame football or Indiana basketball.

In summary, Indiana offers a rich fabric of nationally recognized colleges, and internationally recognized companies, yet while parts of Indiana thrive, there has certainly been a number of small towns, companies, and industries that have been left behind.

On this note, both of my parents were raised in Gary, Indiana, which was once, long ago, one of the most thriving cities in America, yet today, the southern Lake Michigan industrial coast line, from East Chicago to Hammond to Gary, is a shell of its former glory.

Companies, like U.S. Steel (X), who has significant operations in Northwest Indiana, and which I feel is one of the more undervalued equities in the market today, and Cleveland-Cliffs (CLF), another Great Lakes dominant business, which I believe is materially undervalued, went through a long dry spell, as the industrialized heartland of the United States saw production outsourced to cheaper locales, led by China and Mexico.

Jobs were cut, and industrial production centers centered in the Midwestern United States lost their place in the global supply chains.

Even though the fortunes of many of these companies have been revitalized since commodity prices bottomed early in 2016 (alongside a bottom in global growth), followed by a bottom in sovereign bond yields (with a corresponding  top in bond prices), the broader U.S. equity market, which has been dominated by a handful of winning companies, and winning sectors since the current bull market began in March of 2009, has overlooked a small, but significant group of companies, overrun by the passive flow driven rally.

Additionally, many stock markets outside the United States, and associated targeted companies have been left behind too, as global capital fund flows have been recycled to the United States this past decade, driving up the U.S. Dollar Index, and combining with domestic fund flows to passive and ETF passive strategies, to narrow the global equity bull market, led by U.S. equities, to a significantly smaller group of winning companies that one would expect, given the magnitude of the equity rally.

Collectively, the left behind companies and their associated equities, both domestically, and internationally, where there is a greater number of these mis-priced companies, in my opinion, are the forgotten companies.

This is a term, the forgotten companies, that I am going to use over-and-over in the next several weeks and months, to describe the group of undervalued companies that offer rare opportunity, in their equity prices.

For a first-look at the forgotten companies that I will be covering in-depth, and have been covering in-depth, please consider joining The Contrarian, which is my premium research service platform on Seeking Alpha.

I am biased, of course, but I think we have the best group of investors and traders anywhere, seasoned by nearly three years of experience together, positive and negative, and commentary for some members, with many members actively contributing their unique perspectives to a robust Live Chat discussion on a daily basis, particularly when volatility surfaces.

Right now, we have an open free trial at The Contrarian, so if you have ever had an interest in test driving our group, now is a good time.

From my perspective, as I said in my blog posts the past week, it would be worth taking a look, simply to view the Live Chat dialogue.

The price point of The Contrarian is a little steep, coming in as one of the more expensive services in SA’s Marketplace.

Over the years, I have had quite a few requests for a lower-priced, more streamlined research product, and over the last several months, I have slowly put together a more traditional research newsletter.

Ultimately, I think we are now at a major inflection point in the financial markets, which has been ongoing in slow motion for three years, but which could suddenly accelerate. Being different, being contrarian, has been extremely painful for a long time now, however, resilience and persistence, two necessary qualities for success in contrarian investing, in my opinion, are leading to what I believe is an upcoming golden age for active investors.

Disclosure: I am/we are long CLF, MT, X, and short SPY as a market hedge.

Additional disclosure: Every investor’s situation is different. Positions can change at any time without warning. Please do your own due diligence and consult with your financial advisor, if you have one, before making any investment decisions. The author is not acting in an investment adviser capacity. The author’s opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies’ SEC filings. Any opinions or estimates constitute the author’s best judgment as of the date of publication, and are subject to change without notice.

Buffett & Pain & Suffering

(Travis’s Note: I originally wrote this full post on February 2nd, 2017, and I wanted to use/emphasize this excerpt as a reminder of the difficulties that value investors have to endure to see a thesis out).

This correction has been trying on investor’s patience, and it reminded me of a paraphrased quote from an article by Charlie Bilello that our esteemed Contrarian Member from New Zealand, “Motu”, provided a link to earlier in “Live Chat”, essentially saying that, “to be a good investor; you have to be good at suffering”.

In the article, Bilello referenced the famous under-performance of Berkshire Hathaway (NYSE:BRK.A), (NYSE:BRK.B), whose shares declined roughly 50% from June of 1998 to March of 2000, while the Nasdaq 100 rose 270%. Here is the chart of Berkshire’s under-performance, replicated from the article, over that time-frame.

I was an active market participant during this time frame, and made a small fortune from 1995-1999, but as a value investor, I have my painful war stories from this era, which hurt many legendary value oriented investors, including Buffett, Grantham, whose firm GMO lost roughly two-thirds of their clients, and Julian Robertson, who closed his famous Tiger Fund.

My personal learning experience from the late 1990’s including shorting stocks like Intraware and Digital Island too early (November of 1999), and missing out on the downside, while losing significantly, as these aforementioned stocks, and others, doubled in mere days, sometimes in a single day, before ultimately crashing to nothing. This was a painful experience to participate in, and learn from, as my research analysis proved to be right, but my timing and implementation proved to be wrong.

Ultimately, value stocks, particularly small-cap value stocks, and REITs (which ironically are overvalued today), significantly outperformed in the ensuing 2000-2002 bear market. Not surprisingly, Buffett materially outperformed, recapturing the performance gap, and enhancing his already considerable reputation as a legendary value investor.

Wrapping up this opening missive, as a veteran, contrarian, value investor, I can attest to the veracity of the statement that to outperform, you must be good at suffering.

While the most difficult suffering, in my opinion, is waiting for the inflection point in a market, particularly if you are early, there also can be significant suffering once the turn arrives, and a bull market is in bloom.

Building on this narrative, ironically, some of the worst suffering happens during pullbacks in bull markets, as the bull markets want to throw investors off the market, and out of their positions.

Fortunately, bull markets have a way of resolving to the upside after they try to throw the most investors they can off the bull market.

Resilience

  • Spanish football giant Barcelona has an famous youth academy, called La Masia de Can Planes.
  • This academy is widely regarded as the best in the world.
  • Through training hundreds of players, they have found that the number one predictor of success is resilience.  I believe the same thing is true for investing and speculating.

Life Aint Fair(Picture above drawn by my daughter after she was put in timeout)

About a month ago, I was listening to a podcast with Bill Simmons and Steve Nash, and something they were discussing caught my attention.

Specifically, around the 28 minute mark (I would encourage everyone to listen because it really is a good conversation), Steve Nash was talking about the predictors of success in player development, and he referenced the youth academy of soccer giant Barcelona, known as La Masia de Can Planes, often shortened to La Masia.

Per Wikipedia,

“La Masia de Can Planes, usually shortened to La Masia (Catalan pronunciation: [lə məˈzi.ə]; English: “The Farmhouse”),[1] is often used to generically describe the Barcelona youth academy. This academy holds more than 300 young players, and has been praised since 2002 as the best in the world, being a significant factor in FC Barcelona’s European success.”

Nash said that La Masia had found, in its training of the most world class soccer players by any youth academy, that the number one predictor of success was resilience.

Think about that for a second, for developing youth soccer players, the number one predictor of success in the youth academy was not height, strength, speed, coordination, or athleticism, but rather it was resilience.

During the conversation, Nash said that resilience is not really taught, which should be addressed differently.

Nash and Simmons went back and forth ib whether was resilience was something you have inherently, or if it could be trained, or taught.

This observation about the importance of resilience got me thinking about investing, and speculating, and from my personal experiences, my biggest successes usually have occurred after periods of prolonged pain & suffering, or said another way, trials and tribulations.  In short, my biggest triumphs investing and speculating almost always required resilience.

Looking at it from another perspective, sometimes investing, or speculating, (or even life) goes against you, maybe even in a big way, and when this happens, it is crucial, in my opinion that you have resilience too.

Not giving up, keeping at something, this persistence & resilience is not common if something not going a persons way.  Often times, it can lead to success.

One caveat with investing and speculating though, and I suppose this is true in life too, is that I have learned persistence and resilience, or not giving up in the wrong situation, can lead to less than ideal outcome or even catastrophic losses.

So, I suppose the lesson is to be resilient at all times, through successes and failures, and be persistent/resilient if you have reason to believe that failures will eventually pay dividends.

In summary, do not discount the importance of resilience in investing and speculating, or in life,

WTK

P.S. The attached picture above is drawn by one of my daughter’s, composed after she was put in “timeout” that she felt was undeserved, and thus she wrote, “Life Ain’t Fair”.  That is certainly true, and I would add the markets are not fair either, however, it is the job of a successful investor or speculator to have resilience, and take advantage of the price dislocations.

Dollar Divergence

  • The U.S. Dollar Index has rallied this year.
  • However, the Dollar Index has not made new highs on its recent rally.
  • Additionally, the Dollar Index remains materially below its 2015-2017 highs.  What does this mean?

The U.S. Dollar (UUP) has rallied in 2018.

However, if you look at the chart above, it is interesting that the U.S. Dollar Index has not made a new high this year, even with all of the recent tailwinds, including a sharp downturn in U.S. equities, shown by the SPDR S&P 500 ETF (SPY) below.

Additionally, looking at the bigger picture, the U.S. Dollar Index, even with its recent rally, remains substantially below its 2015-2017 highs, as the longer-term chart shows in the following frame.

Interesting, to say the least.

If the Dollar cannot make new 2018 highs with all the recent tailwinds, and remains materially below its 2015-2017 highs, what does that mean?

Is this a positive leading indicator for equities that would rally on Dollar weakness, including emerging market equities (EEM), developed international equities (EFA), international financials (EUFN), commodities, and commodity equities? 

Author’s Highlighted Posts – Punch Card Portfolio – A Take From John Hempton @ Bronte Capital

(Travis’s Note:  This article was originally published on October 20th, 2016, and is being republished on October 28th, 2018.  The article highlights the Punch Card Portfolio Concept, originally derived from Buffett, which we talked about earlier this evening with the re-post of the Buy & Hold article, and this will be a regular topic going forward.  Thus,  this is a foundational article for members, in my opinion.)

  • A look at John Hempton’s view on portfolio strategy and construction.
  • What is the 20 punch card portfolio?
  • Why is a long/short portfolio important as a core, which then can be surrounded by concentrated satellite portfolios?

In my reading, I have come to appreciate the musings of John Hempton, who runs Bronte Capital. The following piece has several nuggets of wisdom, including John’s take on Warren Buffett’s punch card approach to investing, which would limit the number of investments you could make in your lifetime to 20. Once these “punch cards” were used up, you would be out of investment choices. This would emphasize the importance of investment selection, not overtrading, and sitting on your hands, which has become one of my favorite investment expressions.

When thinking through my investment career, looking back through the rear view mirror over the past twenty plus years, I can see mistakes I made by overtrading and these were often, some of the costliest mistakes, as I bought attractive investments and then sold them too early. These so called mistakes often ended up being good, or great investments, but they were not the phenomenal returns that really impact portfolio returns and that could have been achieved by buying and holding these undervalued, contrarian opportunities.

Building on that narrative of the 20 punch card investment philosophy, if we could only make 20 investments starting today, which stocks would we buy? Are there any extraordinary candidates today, like Macquarie Infrastructure (NYSE:MICwas in the spring of 2009? I have some ideas that I will share in the commentary section of the discussion. For now, enjoy John’s view on the topic, his take on portfolio construction, and his evolution as an investor, which has many parallels to “The Contrarian” Portfolios, including the importance of a long/short portfolio, which in our world is the Contrarian “All Weather” Portfolio.

Travis

P.S. Remember the importance of being patient and sitting on your hands! We have seen that lately in our investments.

Comments on investment philosophy – part one of hopefully a few…

This is the first of several investment think pieces I have in my head dealing with investment philosophy, where markets are now and maybe even a stock or two… They are surprisingly hard to write so these posts might come slowly…

When I was starting out in the investment game I read Warren Buffett’s letters from inception, Ben Graham, Phil Fisher, anything I could on Charlie Munger and the rest of the standard investing canon.

One thing that had a profound effect on me was Warren Buffett’s twenty punch card. ( Quoted here…)

Buffett has often said, “I could improve your ultimate financial welfare by giving you a ticket with only twenty slots in it so that you had twenty punches – representing all the investments that you got to make in a lifetime. And once you’d punched through the card, you couldn’t make any more investments at all. Under those rules, you’d really think carefully about what you did, and you’d be forced to load up on what you’d really thought about. So you’d do so much better.”

Buffett is right. That would be a really good way to run your private investments – you would, I think, be very rich by the time you were old. And indeed Charlie Munger has run his career close to that way (though I suspect he is closer to 100 investments by now…)

Charlie Munger has quoted Blaise Pascal approvingly: “all of humanity’s problems stem from man’s inability to sit quietly in a room alone.

There are plenty of people out there who call themselves Buffett acolytes – and as far as I can see they are all phoneys. Every last one of them.

Find any investor who models themselves off Warren Buffett and look at what they do.

And look at their investments against a twenty punch card test.

They fail. They don’t even come close. Several big-name so-called Buffett acolytes have made more than three to five large investments in the last three years and at prices that can’t possibly meet the twenty punch card test. Most phoney Buffett acolytes have been turning stock over faster than that.

Warren Buffett’s two juniors (Todd Combs and Ted Weschler) have turned over many stocks in the past few years too – and at prices that don’t reconcile with any twenty-punch-card philosophy. They are phoneys too. Just a little less egregious than many other so-called Buffett acolytes.

I used to profess myself a Buffett acolyte too. But somewhere along the line I realised I was a phoney too. I just wasn’t close to that selective and when the situation was right I wasn’t anywhere near willing enough to pull the trigger and go really large in a position.

There are psychological feedback mechanisms that stop you meeting the twenty punch-card test. Firstly it is really hard to be that patient. I did not find a new stock that met that test this year. Or last year. Or the year before. Or the year before that. I found one in 2012. And prior to that I had not found a new one since the crisis (when there were many available most of which I missed).

But I am incapable of sitting idle since 2012 (even though the local beach is very good) and so I do stuff. Inferior stuff. Stuff that may produce inferior results.

And some of it (thankfully not much) did produce inferior results. [I was long Sun Edison for example.]

And when you are wrong like that it is scarring. It makes you less willing to pull the trigger in quantity when something does meet the twenty punch-card test.Indeed perhaps the main advantage of the twenty punch card test is the avoidance of mistakes so you can (both psychologically and from a risk-management perspective) take much bigger positions when they come along.

Phoney Buffett-style value-investing is dangerous

A twenty punch card investment portfolio is – by its nature – a concentrated investment portfolio. If I had run my portfolio like that I would have come out of the crisis with maybe six stocks, turfed one or two by now and added a single stock in 2012.

The rest of the time I would have spent reading, talking to management of companies I was never going to invest in, and otherwise tried to work out how the world actually works. (And the world is always more complicated than you imagine so the work is endless even if the activity is muted.)

Many so-called Buffett acolytes (phoneys, all of them) have imbibed that a concentrated portfolio is a good idea. And so they present as having five to twelve stock portfolios and are prepared to take 30 percent positions.

But the stocks often don’t meet the twenty punch-card test. And so these investors wind up with large positions in second rate investments. When one goes wrong it is deeply painful. When three go wrong simultaneously it is devastating.

The lesson here is easily stated: “if you are going to fill your portfolio with crap, it better be diversified crap”.

Several of my favourite phoney Buffett acolytes have been posting catastrophic losses. It was due. The phoney Buffett acolytes still here are just waiting for their turn to have catastrophic losses.

Real twenty-punch-card investing is impossible to sell to clients

Just imagine if I had run a twenty-punch-card style portfolio and sold it to clients. We would have made a bunch of decision in 2008 and 2009 and our numbers would have been stunning to 2012. (Our returns on our longs were very good in those years. Way ahead of market.)

We would have turfed one or two of these. (Some businesses just change, others go up seven fold and are just not worth holding.)

I would have bought a single big position in 2012.

And since about mid-way through 2013 my cash holdings would be going up and up. Partly from dividends, partly from asset sales.

And I would be underperforming now. Quite badly, even though returns would be positive. Come to think of it, my longs mostly are underperforming now. So are the longs of many fund managers I admire.

But mostly I would have been just idle. So in the midst of underperformance a client might ask me what I did last year and I would say something like

a) I read 57 books

b) I read about 200 sets of financial accounts

c) I talked to about 70 management teams and

d) I visited Italy, the UK, Germany, France, Japan, the USA and Canada

but most importantly I did not buy a single share and I sold down a few positions I had.

And I underperformed an index fund.

That is kind of hard to justify. I don’t have a clue how you would ever sell it to clients. I can’t imagine any clients buying it.

And so to my knowledge there is absolutely nobody who is true to the formula and who really runs a concentrated 20 punch-card formula fund.

They are all phoneys because (NYSE:A) the truth is so difficult it hurts and (NYSE:B) the clients can’t handle the truth.

What I did when I realised I was a phoney Buffett acolyte

Somewhere along the line I realised that did not have the temperament to be a true 20 punch-card investor. So I did two things.

a). Rather than accumulate cash and just sit there for very long time periods (five to ten years) I tried to find shorts. The shorts have two benefits (NYSE:I) they turn into cash when the market goes down and twenty-punch-card opportunities arise and (ii) they attempt to make some money on their own.

b) I run a portfolio that is more divesified than I desire. I desire to be 15 stocks in 15 industries and seven countries, though in reality my desire should be to be more concentrated than that. [I would/should be happy with five 20 percent positions as long as they all meet the 20 punch-card test.] Alas (justified) lack of conviction means my portfolio is about 45 long positions – many of which are for sale when a better idea comes along. In other words when I hold crap at least I diversify it.

This is not entirely satisfactory. I get some longs wrong and lose money on those. And the shorts can be difficult to make money on even when you are right. A stock that goes from 10 to zero might look like a great short but if it goes via 50 then you are likely to be forced to cover some on the way up and its unlikely you will ever recover your losses.

We have strategies to manage both those problems and the results have been and will remain satisfactory although they will not always glow. There can be sustained periods of dull performance. And whist this is not as hard to sell to clients (or yourself) as a true 20 punch-card portfolio after a couple of years dull performance can become exhausting. Clients who haven’t lost any real money will leave – because there is always someone else who is making money – and the grass is always greener – and because clients see performance more than inherent risk in any portfolio – and low risk portfolios can be dull.

Portfolio managers I admire

I still admire Buffett’s portfolio management more than I can say. He really is astonishingly good at what I have chosen to do for a living.

But I can’t emulate Buffett and nor can anyone else I know. And if someone uses his name to describe their investment philosophy my (likely accurate) presumption is that they are a phoney.

There are other managers I admire. I still think Kerr Neilson at Platinum is a freak but it is awful hard to emulate him though in at least part of my portfolio I try. I worked for him for seven years and have some idea how he does it. [He is unbelievably good at cyclical stocks for instance – something Buffett professes no desire to do and which I lack some of the skills necessary to do.]

But almost every other portfolio manager I admire is a long-short manager who has come to an investing compromise like mine. They aspire to be world-class long investors but irregularly fill their portfolio with more diversified second-class stock picks. And they run short books.

And the short books hopefully make money on their own – but mostly make money at the right times – delivering their profits in down years like 2008, and stripping them of profits in super-strong markets.

The problem is that almost every one of these managers is having a dull patch at the moment. These are people I think are amongst the best in the world. And I think (without naming names) that they are having the dull patch the same way as I am. In particular it is devastatingly hard to find things that meet the 20 punch card test. [If you have one please email me. I am prepared to listen to almost anything.]

So instead they have been buying things which are “ownable” rather than “buyable”. In other words things that are sort-of-okay in that if you owned them for a decade you would probably be happy enough but not thrilled with the result. And the results from doing this have – at least over the past year – been dull. [Exception: if you bought pure bond sensitives as an alternative to bonds you did really well – but alas I did not do that…]

And the good long-short managers have found it easy to find egregious crap to short. Stuff where the story has more resemblance to fantasy than reality. The typical tell is massive differences between “the story” and the GAAP accounts”.

Some of these fantasy stocks have blown up (Valeant, Concordia) but many are alive and well and when I describe them as fantasy stocks I just get back hostility. And as a rule long “ownable”, short “fantasy” has not worked that well. Truth be told it has produced results that somewhere between 5% positive and 5% negative. It has been hard work to go nowhere.

And there are fund managers who are doing better. Some of them have tricks I do not understand (I put David Tepper in this camp – I simply don’t get how he does it and hence can’t emulate it*). But the ones I do understand I don’t like. Their chance of a plus 20 is clearly better than mine. And their chance of a minus 40 is alas even better than that, and that is something I find abhorrent even if the clients are seduced.

John

*The Tepper trade that most impressed me this cycle was long the airlines. I had enough knowledge to know this cycle would be good if I put the pieces together. But I did not put the pieces together and my allergy to capital intensive competitive businesses overwhelmed common sense. Tepper made a great trade that almost any Buffett acolyte would have ignored.

Disclosure: I am/we are long THE POSITIONS IN “THE CONTRARIAN” PORTFOLIOS.

Additional disclosure: Every investor’s situation is different. Positions can change at any time without warning. Please do your own due diligence and consult with your financial advisor, if you have one, before making any investment decisions. The author is not acting in an investment adviser capacity. The author’s opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies’ SEC filings. Any opinions or estimates constitute the author’s best judgment as of the date of publication, and are subject to change without notice.

Toys “R” Us

(This article was published on August 28, 2018, and is being re-published on October 28th, 2018 to add to the archives.)

  • This was an actual conversation today.
  • Seeing the world through the eyes of a 6-year old.
  • Did Toys “R” Us have to liquidate?

Today, I picked up my youngest daughter from school.  The following was the actual conversation to the best of my memory.

(WTK): I am here to pick you up.

(Daughter): Where is mommy?

(WTK): She is teaching middle school today and is with your sister’s class.

(Daughter): Ask Siri on your Apple (AAPL) phone where I can buy L.O.L. dolls?

(WTK): Why would I do that?  They are like $30 or something like that.  The only person L.O.L’ing is the people who are selling these.

(Daughter): What?  Never-mind.  You can buy them at Target (TGT), Wal-Mart (WMT), and you used to be able to buy them at Toys “R” Us.

(Daughter): I have one question.  Why did they close down Toys “R” Us?

(WTK): Do you really want to know?

(Daughter): Yes.

(WTK): Toys “R” Us had too much debt from when private equity players Bain Capital and KKR (KKR) teamed with Vornado Realty Trust (VNO) for a leveraged buyout.  They had to pay too much interest from this debt, and with competition from Amazon (AMZN), Target, and Wal-Mart, it was too much.  Also, believe it or not, five hedge funds who held their debt, including Oaktree (OAK), who you care nothing about, made the decision to close down the Toys “R” Us stores, rather than keep them operating.

(Daughter): Wait…wait a minute.  So they did not close down the stores because people were not buying toys there?

(WTK):  That was part of it, but mostly it was the interest on the too big of pile of debt.

(Daughter): That is so frustrating.  Now I can’t buy L.O.L. dolls at Toys “R” Us anymore.  Life is so unfair.

(WTK): Unfair?  I will tell you about unfair.  Did I ever tell you I got the big picture right for coal, meaning a historic turnaround in coal prices, yet distressed debt buyers got all the benefit.

(Daughter):  I do not want to hear about that anymore.

(WTK): Anymore?

(Daughter): I just want to talk about Toys “R” Us.  It does not make sense.

(WTK):  I know.

P.S. When I was a young kid, all I wanted to do was have enough money to buy whatever I wanted at Toys “R” Us.  I guess somethings never change.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: Every investor’s situation is different. Positions can change at any time without warning. Please do your own due diligence and consult with your financial advisor, if you have one, before making any investment decisions. The author is not acting in an investment adviser capacity. The author’s opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies’ SEC filings. Any opinions or estimates constitute the author’s best judgment as of the date of publication, and are subject to change without notice.

Exiting Purgatory

(Travis’s Note:  This article was originally published on June 11th, 2018, and is being republished on October 28th, 2018 to add to the archives.  The title of this article was called “Exiting Purgatory”, however, that was a premature assessment.  Purgatory has continued for many out-of-favor equities, far longer than I would have thought two years ago, however, a historic rotation, even bigger than the reversal and rebound that encompassed out-of-favor equities in 2016 is on the horizon.)

  • 2016 was terrific, one of my best years ever, and this emboldened me heading into 2017.
  • The following 16 months might have been the worst period of my two decade plus investment career, and that is saying something, given the highs and lows I have achieved.
  • During the past two months, prices of my targeted equities have synced up, once again, with the dominant investment narratives that have prevailed since 2016.

It is no secret that the 16 months spanning January of 2017 to April of 2018 brought me to my knees, and then some, after one of the best macroeconomic and bottoms-up research calls of my roughly two decade career.

The investment markets, much like life, offer unexpected twists and turns, and they can humble us more than we can imagine.

As market participants, it is up to each one of us to learn, and benefit from our mistakes and successes.

Staying the course, I remain convinced that we are on the cusp of a generational investment opportunity, and there are valid reasons to be both extraordinarily bullish and extraordinarily bearish.

Last Thursday, I published an article for members, and as one part of the article, I looked at the performance of The Contrarian’s Top-Ten List from 4/5/18 through 6/6/2018.

With the equities names blanked out, here are the performance metrics over this time frame.

  1. Equity One – Gain of 6.6%
  2. Equity Two –  Gain of 41.9%
  3. Equity Three – Loss of -25.0%
  4. Equity Four – Gain of 19.7%
  5. Equity Five – Loss of -19.9%
  6. Equity Six – Gain of 5.8%
  7. Equity Seven –  Gain of 97.4%
  8. Equity Eight – Gain of 60.9%
  9. Equity Nine – Gain of 40.0%
  10. Equity Ten – Gain of 2.7%

Looking at the above list, clearly something has changed.

What has happened?

The short answer, is that purgatory is over.

Hope everyone is having a nice start to the summer,

WTK

Disclosure: I am/we are long the positions in the contrarian portfolios.

Additional disclosure: Every investor’s situation is different. Positions can change at any time without warning. Please do your own due diligence and consult with your financial advisor, if you have one, before making any investment decisions. The author is not acting in an investment adviser capacity. The author’s opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies’ SEC filings. Any opinions or estimates constitute the author’s best judgment as of the date of publication, and are subject to change without notice.

My July 18th, 2016 Oil Forecast

(Travis’s Note:  This article was originally published on May 14th, 2018, and is being republished on October 28th, 2018, to add to the archives).

  • The snapshot below shows my 7/18/2016 oil price forecast.
  • How it helped.
  • How it hurt.

One of my long-time members of The Contrarian, a friendly fellow from New Zealand, bookmarked my July 18th, 2016 oil price (USO) forecast, and posted it to our forum several days ago.  Here is the snapshot of the oil forecast below, with the forecast highlighted in yellow.

Ultimately, knowing the “macro”, and getting it right, is usually helpful, however, in this case, it has been very painful, at least in the short-run.

Why is that?

Well, despite a near tripling of oil prices from their 2016 lows, there has been a dramatic divergence in energy equities (XOP), (XLE), (OIH), particularly the energy equities that should benefit the most from higher oil prices.

This has created a huge opportunity right now, IMO.

Hopefully, many can take advantage of this divergence, which is just starting to get resolved,

WTK

Disclosure: I am/we are long the positions in the contrarian portfolios.

Additional disclosure: Every investor’s situation is different. Positions can change at any time without warning. Please do your own due diligence and consult with your financial advisor, if you have one, before making any investment decisions. The author is not acting in an investment adviser capacity. The author’s opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies’ SEC filings. Any opinions or estimates constitute the author’s best judgment as of the date of publication, and are subject to change without notice.