Really, I would say that this Blog is not yet full of single name investment ideas, because they are not warranted, yet.
The above is a graph of American Italian Pasta Company (AIPC), a company I have owned since April 2007. At various points in time I have traded around the position, always keeping a long bias (since April 2007), and today I remain long. It’s probably one of the cheapest stocks I see right now, even considering that it is up 13% YTD, 18% in the last year, and 566% in the last 2 years. There are many ways to “play the name” – short puts (vol is high), buying calls (stock trends up), or owning the stock (stock is up), and my view is that owning the stock is the best way to play it right now as the company will likely merge or recapitalize in some fashion in the next two years.
I could also discuss some other ideas that undoubtedly would probably sound highly convincing…. Indeed, I could even point to experience: as of today, my personal investment trailing 24 month internal rate of return is over 50% annualized and my personal investment internal rate of return since October 2005 is 34% annualized. But I think it’s more important to focus on the big picture, as based on my experience, returns in general are produced by two things that go beyond a good story: distress, and macro value.
I suppose it’s possible to add a third – growth / technological change (the Googles, Apples, and Microsofts) but for whatever reason, those are not my edge or interest. As much as I do actually believe the iPad will revolutionize business by reducing paper and bringing in multi-media reports that will greatly enhance productivity, risk adjusted, I don’t find interesting Apple, Google, vmware, and many other grow techs that will benefit with this trend, so I will focus on the first two factors – distress and macro value trends.
What is distress? American Italian Pasta Company (AIPC) was a distressed story (the company sustained an accounting fraud as the management tried to find growth in the pasta industry where little existed), and to some extent, is still recovering (and producing outsized distressed recovery returns). The distress will end when the capital structure of the company normalizes. Similarly, CIT Group, which I mentioned here, is a distressed story that will take a few more years to play out. In the case of CIT, I think the recovery will be best felt in the debt securities (at least initially). In any case, these are decent examples of distressed value trades.
What is macro value? The stock market of 2007 – 2008 (from a short perspective) and the various other trades related to housing were macro trades. The macro trend was extension and over-extension of credit paired with declining lending standards.
So to the question at the top: Why am I not currently focusing on single name stock ideas, and, conversely, why do I currently discuss macro trends like evidence of recovery and whether or not equities are a “buy” as an asset class? In short, I think the distressed play is largely over – until we go through another cycle of distress which could happen around late 2011 to early 2012 in my opinion – and so the focus now shifts to understanding fund flows and macro trends (see the graph left – focus is especially on where funds will be flowing next as opposed to where funds have been flowing).
So that brings us to equities as an asset class. In short, I continue to see evidence of a recovery which is beneficial to equities at todays valuations. For instance, the graph to the left from Charles Grom and team at JP Morgan shows furniture buying improving after two years of weakness.
Sure, it’s easy to still be bearish on all asset classes – obviously the spending by the governments of the world is not sustainable and will end badly in many cases, but that doesn’t mean that it will be equities that suffer, or, for that matter, that it will be equities that suffer now.
From what I can see, bonds are getting very late in the recovery cycle, and focus is likely to shift to equities in the coming months. So given that as a backdrop, I am stressing the macro trend because it is likely that what one buys is less important than just recognizing that in buying an equity, the “wind is at your back” today: “a rising tide lifts all boats.”
Actually, the boats are already rising…. The S&P is up 5% YTD and 39% in the last year, meaning one could have bought an “average” stock – or just have bought the market, and have gotten an above average return (at least relative to history) that is as good as or better than a value investor return. Said even more simply – with the market putting up those kinds of returns, one could have bought practically anything and made money. Indeed, during this time period, the worse quality companies have posted the highest returns.
I do note that the recent return of the market is not a reason to fear a change of fortunes in my opinion, as it seems more likely that the investing public will take notice of these returns and “pile in”, especially considering cash and bond yields today. And regardless, even after these returns, valuations seems decent as the equity market lows were truly distressed valuations.
A note about Value Investing: Yes, I think it’s easier to sleep at night with a value investor’s mentality, and in owning companies that are inherently more stable or cheaper, and through trade strategies that have a natural margin of safety – and I employ all of these tools – but these are only ways to make decent investment materials better. If the market as a whole is unsuitable, these tools will dampen the impact of, but not save one from, a correction. And make no mistake: Value Investing is ultimately about maximizing the compounding of investment capital, which means a primary focus is on side-stepping declines, and participating in rallies.
So in conclusion, some equity rallies may be irrational and predictive of future declines (like the dot com bubble and the debt led boom into 2007), but I don’t think we’re there yet, at least not in today’s equity market. We’ll know more about the bond market in a few weeks….
Arthur O’Keefe, São Paulo Value
The above is the FXE Euro Trust Currency Shares vs the S&P Trust. As much as I am fundamentally bearish in today’s environment, the above is Bullish for equity valuations – at least relative to Europe. Why? The general environment continues to me heavily macro and volatility driven. From the strengthening of the Euro, and its recent breakaway/outperformance, we see that despite fundamental weakness, the world is settling down.
So we have short term bullish and long term bearish = continued volatility. Actually I am starting to get excited with investment opportunities now that immediate crises are over (Greece and many state governments will default but not today). Volatility creates great trading opportunities – but they are that – trading opportunities. Money is made in this environment providing liquidity and then taking it back as it becomes plentiful. Said another way – buying low and selling high.
