HCP, Inc.., a REIT with a 6.4% dividend yield. HCP has 1,200 properties specializing in senior housing, life science and medical offices, with a diversified mix of independent and assisted living. Shareholders have enjoyed a compound annual return of 14.9% since their 1985 IPO, and HCP has increased their dividend for 31 consecutive years. Healthcare expenditures are set to increase with the “graying of America” and HCP is well-positioned to capture this secular growth with their unique, diversified real estate portfolio.
Home Depot (HD) – Boomers entering retirement will spend their free time fixing up their homes, or spending money on second homes to renovate. The stock yields 2.25%, ahead of the S&P 500, and recently hiked their dividend by 17%. Home Depot is the 2nd-best performing stock of the last 30 years, with a cumulative return of nearly 68,000% or ~24% annualized. Revenues should hit $100 billion in 2018 and the industry enjoys long-term secular tailwinds in an aging housing stock and new household formation.
Amazon, Inc. (AMZN) – As boomers age, their preference will shift towards the convenience of ordering online rather than driving to the store. Bezos’ e-commerce monster now captures over 50 cents of each incremental dollar spent online and twenty years of reinvestment are finally showing up in the form of margin expansion and triple-digit growth in free cash flow. Other growth drivers include Prime Video and the firm’s recent entrance into logistics.
MONTH END– Last day of the Month today, and a Big Mutual Fund Year-End date. Don’t think we will see any “Window Dressing” (usually occurs into Dec31), but we may see some of these big “Tax Loss” Candidates see relief from recent selling pressure.
The Fed’s preferred measure of inflation is due later[wsj.com]Monday. Rising inflation and rising yields could undermine the relative value case for stocks, with the correlation between bond and equity prices now positive – Economic circumstances and attitudes of policy makers[wsj.com] have shifted in the past year in ways that suggest the likeliest path of inflation is up, not down. Data released Friday showed that core inflation, which excludes food and energy, reached a two-year high of 1.7% in the third quarter, according to the Fed’s preferred measure. Other data found stirrings of wage acceleration – Global Yields are modestly lower this AM
Japan’s industrial output stalled in September in a worrying sign[asia.nikkei.com] that the economy, already struggling to mount a sure-footed recovery, may be losing some momentum due to weak consumer spending and exports – Separate data showed retail sales fell more than expected in September from a year ago, further evidence that private consumption remains a drag on growth. The yen is slowly coming down from its lofty heights as markets grow more conscious of interest rates gaps between Japan and the rest of the world, giving a lift to the Japanese economy. While long-term interest rates are rising in the U.S. and Europe, those in Japan are pegged at zero.
Short Selling In A Bull Market – Common Mistakes In Security Selection by Greg Blotnick, CFA
It was June 22, 2015 when both articles came out. The NY Times authored a piece titled “The Loneliness of the Short-Seller” and later that day the Financial Times released “Shorters needed.” If past is prologue, the media tends to do a fantastic job at marking turning points – all the way back to Barrons’ infamous cover story “The Death of Equities” in 1979. Contrarians should take note, as the S&P has drifted even higher since journalists lamented the death of short selling sixteen months ago.
Today’s market, while not egregiously overpriced, offers poor risk-reward in comparison to the opportunity set investors were presented in the early 1980’s: an S&P 500 trading at 8-9x earnings combined with double-digit interest rates in decline. 2016 presents the inverse: a fully-valued market combined with rates at the zero-lower bound and climbing, serving as a headwind to further multiple appreciation. For those of us not forced to be fully invested, this is an ideal environment to overweight cash and begin stalking new short ideas. Here are three of my preferred criteria:
1. Cheap Stocks Make Better Shorts Than Expensive Ones.
Investors are easily swayed by the allure of a low trailing P/E ratio. It saves them from having to forecast the future, which requires work, and serves as a simple crutch for justifying an investment to colleagues or investors (“the stock is cheap!”). Experienced investors and short sellers know that a low P/E ratio is the sign of a business facing severe headwinds – either cyclical or secular – and that earnings are likely in decline. Forecasting earnings two or three years out often reveals that what appears to be 10x trailing earnings is a value trap, as the stock is trading at 20x forward or 30x earnings multiple years out.
For these optically cheap short candidates, secular headwinds are preferable to cyclical. Share prices of cyclicals tend to move swiftly and unexpectedly from the bottom and can quickly lead to large losses, especially businesses with heavy financial and/or operating leverage. At the risk of stating the obvious, the best short candidates are melting ice cubes where the probable outcome is a slow bleed to zero; rather than having to time covering a short, the decision is made for you when the stock gets delisted. Jim Chanos is often asked about the asymmetric upside risk from a short and gives a simple response: “I’ve seen more stocks go to zero than infinity.”
2. Go Where There’s Dumb Competition.
One under-utilized screen for short candidates: stocks with high retail ownership. The general investing public tends to fall for the usual “Three F’s” of short schema (fads, frauds and failures) far more often than professional investors. The ETF/passive boom has spawned profitable short targets as well, particularly decaying levered ETF’s or the rise in oxymoron “low-volatility equity” products. Quantitative screens exist to find ‘retail clustering’ but qualitative analysis is more useful: go through SeekingAlpha comments sections, StockTwits’ “trending” bar, and the Twitter stream for a given stock.
Other than fads and frauds, yield plays are honey to the retail bee – particularly in the current low-rate market environment. Some recent examples include MLP’s/offshore driller drop-downs or other ‘yieldco’ capital structures that have no fit with the economics of the underlying assets and exist primarily to enrich management at shareholders’ expense. Screening for stocks with double-digit dividend yields often reveals short candidates, as the market is signaling the dividend is unsustainable and likely to be cut or suspended entirely. The caveat is that timing these shorts can be difficult as they are most akin to shorting a bond – high cost of carry accompanied by an event where the instrument loses 25%+ of its value overnight.
3. Beware The Embedded Macro Bets In A Stock.
David Tepper frequently preaches this: investors often ignore the embedded macro bets they are making. For example, consumer staples today trade at 20-25x earnings despite flat top line and mediocre earnings growth. Why? In an environment with zero and negative bond yields, a 2-3% dividend is a healthy substitute and offers the added benefit of pricing power to offset inflation. The same can be said for some REITs and Utility stocks – it is simply a market truism that stocks occasionally disconnect from fundamentals for long periods of time. If you are short any of these three sectors and rates continue their rapid decline, you will lose money regardless of the business’ underlying performance.
Other examples of dangerous embedded macro bets would be shorting commodity-linked energy or basic material companies. The equity in a distressed and over-levered shale driller may be worthless with WTI crude at $30, $40 or $50 – but being short said driller as crude goes from $30 to $50 can quickly lead to a 500%+ unrealized loss. Pay attention not only to leverage but to how the stock price has historically correlated to the commodity it tracks and what sort of beta it has to the underlying.
Good luck trading,
Greg Blotnick, CFA
About the Author
Author biography: Greg Blotnick is currently a long/short equity analyst at a private investment firm, covering consumer, TMT and industrial stocks. Greg has spent his entire career in the asset management industry and served as a fundamental analyst for former multi-billion dollar hedge funds. Greg’s experience spans multiple investment strategies including long/short equity, credit, event-driven and capital structure arbitrage. Greg holds an MBA from Columbia Business School and a B.S. in Finance from Lehigh University, and is a CFA Charterholder.
Market update – the main highlights for Mon morning are strong flash PMIs (from Europe and Japan) and a lot of M&A. The M&A in particular is interesting as it appears the combination of greater US election clarity and the prospect of higher borrowing costs is sparking an acceleration in deal activity. The notable transactions from over the weekend include T/TWX ($85B equity value, $108.7B total consideration), COL/BEAV ($6.4B equity value, $8.3B total consideration), GNW/China Oceanwide ($2.7B equity value) and AMTD/TD (~$4B deal value). Also, QCOM may purchase NXPI as soon as this Wed (in a deal likely to be worth ~$37B). On the economic front, the flash PMI numbers are encouraging (esp. in Europe). The Bottom Line for US equities remains the same – while the ingredients for a year-end rally could fall into place (see the “checklist” below), it still seems like the SPX faces an ultimate ceiling up around ~2200 for the time being (as firming yields cap multiple expansion and the ’17 consensus EPS estimate fails to move higher).
HEADFAKE?– China’s producer prices rose for the first time since 2012, indicating further stabilization[straitstimes.com] in the world’s second-largest economy – Producer prices edged up 0.1 per cent from a year earlier, the National Bureau of Statistics said on Friday (Oct 14), compared with the previous month’s fall of 0.8 per cent. It marked the first growth in PPI since January 2012.
China power use growth, a key barometer[shanghaidaily.com] of economic activity, accelerated in September due to more consumption by the service sector, an increasingly significant driver of the Chinese economy, official data showed yesterday. Electricity consumed by the service sector expanded rapidly in September, with information, computing and software industries surging 17.1 percent year on year – Once again, Was the Chinese Trade Data yesterday skewed due to the Hanjin Bankruptcy?
There was MASSIVE protection buying yesterday on the angst about Chinese Trade – The CBOE US Equity Put Call Ratio Intraday (PCRTEQTY) hit 2.52 – A VERY big BUY Signal for Contrarians
China is planning to merge[straitstimes.com] Sinochem Group and China National Chemical Corp in what would be a combination of two companies with more than US$100 billion (S$138.49 billion) in assets as the government continues its overhaul of state-owned enterprises. It was also not clear how the the plan would affect China National Chemical, also known as ChemChina, and its proposed acquisition of Syngenta for a record US$43 billion – Banks are on Fire in Europe right now as Chinese Headers abate fears of a massive slowdown
BANKS AND RETAIL– Retail sales, a closely watched indicator of consumer spending and a key driver of overall growth, have sputtered in recent months following a strong start to the year. That should change Friday[wsj.com] when the Commerce Department releases its monthly retail-sales data, which measure everything from traditional stores to restaurants to online retailers.
Predictions for the more representative “control group” also look decent. Items excluding cars, gasoline and building materials, which are often volatile month to month, are expected to have increased 0.3% after falling for two straight months – Evidence is mounting that overall retail sales might have picked back up following a summer lull. U.S. consumers were more active last month than in any September since 2008, according to Gallup – XLY (Discretionary) had a close test of the 200dma before rebounding yesterday.
“Options protecting against a 10 percent drop in the XLF cost 9.5 points more than calls betting on a 10 percent rise on Sept. 30, according to six-month data compiled by Bloomberg. That marked the highest spread since April 2014. The spread was 6.8 points on Wednesday, still 11 percent above the measure’s two-year average.” Sounds crowded – “Sell the Rumor, Buy the News?” JPM up near YTD highs as They beat along with C and WFC
Investment-banking revenue is set to rise 3% in the third quarter thanks in part to a pickup in bond issuance, according to Nomura analysts[blogs.wsj.com]. But that rise masks some deeper concerns in the business. Revenue in stock underwriting is lower than it has been in 20 years, and the dollar volume of deals completed during the third quarter fell 12% from their level in 2015, according to Dealogic.
FEDSPEAK– Fed may have to hike rates faster than it now forecasts, Rosengren says[marketwatch.com] – “My own view is that if the unemployment rate falls as much as I’m expecting than it is possible that we’ll have to raise rates faster than the summary of economic projections” – At 1:30 PM, Speech by Fed Chair Janet Yellen, at the Federal Reserve Bank of Boston’s Annual Research Conference: The Elusive “Great” Recovery: Causes and Implications for Future Business Cycle Dynamics
Traders have priced in a greater than 60% chance of a rate hike at the Fed’s December meeting, when Fed Chairwoman Janet Yellen is scheduled to hold a press conference. “To me that seems quite appropriate,” Rosengren said. “We have tended to move around the time the Fed chair has a press conference” – The US 10YY remains upside it’s 200dma.
Early Earnings returns[macro-man.blogspot.com] have not been encouraging, and companies have retreated behind the excuse of the strong dollar to justify their poor performance. Indeed, of the first 25 s&p 500 companies to report, 60% had a moan about the strong dollar.
Bespoke notes[bespokepremium.com] just over two weeks ago, on 9/23, the sector’s 10-day A/D line rose to its highest level since March. As if a light switch suddenly went on, though, the next ten trading days saw extremely negative breadth as the 10-day A/D line cratered to its most oversold level since November 2012 and one of the most oversold readings for the sector on record.
SPX cash 2120 support held yesterday, but we have fallen below that 100dma and long-term uptrend. We need a recovery today
FLOW SHOW(EPFR and Lipper) – Lipper[in.reuters.com] said money-market funds posted $10.6 billion in withdrawals during the week – This came ahead of reforms, taking effect on Friday, that would force some funds to let their share prices float with the market.
Some $1 trillion[bloomberg.com] worth of assets have shifted from prime money market funds into government money market funds that invest in safer assets such as short-term U.S. debt, according to Bloomberg estimates. The exodus has driven up Libor rates as banks and other corporate entities compete to replace the lost funding.
· European stocks recorded $1.1bn of withdrawals in the week to October 12, the 36th consecutive week of outflows, according to fund flows tracked by EPFR.
· European bond funds were hit with $2.2bn of outflows – the largest weekly withdrawal since June 2015.
· Non-U.S. stock funds attracted $561 million and their first week of inflows since late August – Emerging market stock funds took in $764 million, and Japanese equity funds added $106 million in their first week of inflows since July
· $3.4b outflow from equity funds/ETFs this week. Negative 34 of past 41 weeks.
· $2.1b outflow from taxable bond funds. Positive 30 of past 41 weeks.
· U.S. high-grade bond fund outflows fastest since March
· High-yield junk bond funds had $72 million in withdrawals, and investors pulled $385 million from Treasury funds
INVERSIONS– The Obama administration, in its latest bid[reuters.com] to prevent American companies from minimizing U.S. taxes by rebasing abroad, issued final rules on Thursday to combat a key tax-reduction technique known as earnings stripping – Six months after proposing the regulations, the U.S. Treasury made good on its pledge to move swiftly against corporate tax inversions by rolling out the new final rule, despite opposition from business groups
· Cross-border M&A activity fell by nearly a fifth in the third quarter of 2016, as political uncertainty stifled dealmaking – There was $373 billion of cross-border activity in the quarter, according to new data from law firm Baker & McKenzie[city.wsj.com]. A -22% Change in volume from Q3 2015. The report cited three key drivers for the macro-political uncertainty: Brexit vote, US elections, Tightening of US monetary policy
GOLDEN?– Demand for gold in India[kitco.com], the world’s second-largest consumer, picked up as the festive season began and discounts narrowed, while demand across rest of the Asia continued to improve – Gold discounts in India narrowed to the smallest level in nearly nine months as prices fell during a key Hindu festival Dussehra boosted retail demand.
OUTAGE– “U.S. crude’s structure gained support from the extended outage[reuters.com] of a pipeline capable of delivering 450,000 barrels per day of crude into Cushing” Plains All American’s Basin pipeline is the largest outbound pipeline from the biggest oil shale play in the United States, the Permian Basin, and news[businessinsider.com] of the extended outage caused a narrowing in the spread between the front-month to second-month crude contracts, as traders anticipated a draw of nearly 2 million barrels a week from Cushing due to the outage.
Oil is battling to stay upside $50 into Expiry Monday.
SOME OF THE OTHER HEADLINES
SKITTISH – Only 30 percent of Japanese households have experience investing in stocks and nearly 80 percent say they would not take on risk even for an investment yielding significant returns, a survey showed, underscoring the difficulty of reversing the risk-aversion widely blamed for prolonging Japan’s chronic deflation. The poll[reuters.com] of 25,000 households conducted from Feb. 29 to March 17, is the first most comprehensive survey in Japan on financial literacy and households’ investment behavior.
BEAST – SoftBank and Saudi Arabia have teamed up to launch[city.wsj.com] a giant tech fund based in the UK. The Japanese internet and telecommunications conglomerate said Thursday that it expects to invest at least $25 billion over the next five years. The Public Investment Fund of Saudi Arabia will consider contributing $45 billion over five years to the new fund as a lead partner. SoftBank added that the fund could eventually reach $100 billion, as other “global investors” come onboard. The move by SoftBank follows its acquisition of FTSE 100 chip-maker ARM for £24 billion this summer.
HARD EXIT – ‘Hard Brexit’ or no Brexit, Donald Tusk warns UK[ft.com] – Idea that Britain can retain benefits after leaving is ‘pure illusion’, says European Council chief – Comments by European Council President Donald Tusk, who will run the Brussels side of Britain’s negotiations on leaving the EU, that the bloc will not offer London any softer terms than a “hard Brexit” helped keep the pound under pressure. Such a deal would end Britain’s membership of the single market and disrupt access to the country’s main trading partner.
AHEAD OF US THE REST OF THE WEEK
China – CPI, PPI
A$ – RBA Financial Stability Review
JPY – Japan to Sell 5-Year Bonds
EU – Trade Balance
MARKETS – Money Market Reform implemented
FED (8:30) – Fed’s Rosengren Gives Opening Remarks at Boston Fed Conference
ECO (8:30) – PPI; Retail Sales Advance for September
ECO (10) – Business Inventories; U. of Mich. Sentiment
FED (12) – Fed Chair Yellen Speaks at Boston Fed Conference
-Banks kick off earnings season with decent beats, but point to ongoing NIM
pressures, even with a Dec Fed rate hike, and other macro and regulatory
challenges to achieving good EPS growth in 2017. We expect the rest of 3Q
reporting season to be even more sobering. Most companies will beat the last
minute estimates, but beats will be smaller than usual and 4Q16 and 2017 EPS
outlooks will be tempered. The greatest risk of disappointment is at Consumer
stocks, Industrials, Materials and even Energy despite low expectations. We
believe Tech & HC will have among the more encouraging results and outlook. 3Q S&P EPS is likely ~$30.00 or flat y/y or up 3% ex. Energy, Fin & Real Estate
Today’s bottom-up aggregate analyst 3Q EPS estimate for S&P constituent companies as of Sept end is $29.98, which compares to $30.12 in 3Q last year. On a current constituent basis, we expect S&P EPS flat y/y or up 2% q/q. 3Q EPS growth should be 3% ex Energy or ex Energy, Fin & RE. S&P EPS growth ex. Energy, Fin & RE has slowed in recent quarters to ~3% and 3-5% seems most likely for 4Q16 & 2017. Oil prices remain a wild card for 2017, but we expect oil to avg. $55/bbl and the Energy sector to earn $48bn. The aggregate market cap of the Energy sector is $1.35trn or 28x 2017E EPS.
The direction of fundamentals matters, but what’s priced in matters most
In recent weeks, spot oil climbed to a bit over $50/bbl and 10yr Treasury yields climbed to slightly exceed 1.75%. Rising oil is good for Energy earnings and rising long-term yields better compete with dividend yields, but the direction of such fundamentals must be judged relative to the destination expected or priced by the stocks via their valuation. In the case of Energy, we believe oil must climb to $70/bbl by 2018 to justify today’s observed valuations and make their forward PE fall to about 15-16 by 2017 end from 28 today. Because we’re skeptical of $70/bbl oil in 2018, ~$60/bbl seen as more likely, we think the Energy sector will be flat to down 20% in 12-months. In the case of Utilities, we think 10yr Tsy yields must climb to 4.5% in 2018 to make the sector’s 17x forward PE fair. Because we expect the 10yr yields to stay below 2.5% in 2018, and real long-term yields not to exceed 1% for many more years, we think a 20-22 forward PE (3.0% div yield) is fair for Utilities suggesting 15-25% upside.
Consider CAPM in a 1% real Rf rate world: High dividend cyclical most at risk
Right now, 10yr TIPS yield 10bp, up from 0bp a few weeks ago, which suggests the 25bp climb in 10yr yields is mostly from higher expected inflation. PEs are influenced by real interest rates and a fair real cost of equity. We value the S&P by assuming 10yr TIPS will yield 1.0-1.5% around 2025. To this expected “normal” real Rf rate, we add a 400bp Equity Risk Premium to estimate the S&P’s overall real Ke at 5.0-5.5%. By sector, we adjust the ERP depending on its beta or cyclicality. By this method, the real Ke for defensive sectors with a 0.8 beta is 4.5% and for cyclical sectors with a beta of 1.2 about 6%. This suggest that a fair PE on normalized trailing non-GAAP S&P EPS is ~18.5 (1/real Ke), but 21-23x for most defensives and 15-17 for most cyclical sectors (1/real Ke). We don’t think low beta bond substitutes are overvalued, rather we fear many cyclicals with 3%+ dividend yields are pricey because investors are overlooking macro risks and challenges for 3%+ dividend yields.
QUICK READ: China taketh away, and China giveth back…
The tenuous effects of (and newest iteration of) “global growth scare v3.0” from earlier in the week–off the back of the bad China export data print and the implications of a “strengthening too fast” US Dollar–were washed away overnight, following Chinese PPI printing its first month of YoY growth since Jan 2012.It seems rather obvious then that the pickup in Chinese inflation has been driven by the recovery in oil, while too recently picking-up the tailwind of the RMB depreciation as well—potent stuff.
As such, we are again seeing “pro-cyclical” risk leadership out of the overnight trade—global core rates are again higher (UST 10Y at 1.776) seeing bear-steepening through long-end weakness (Gilts really breaking-down on the “bad kind of inflation” narrative in the UK post the GBP move, yields at highs since Brexit vote day), WTI crude is +1.0%, Spooz +8 handles and EU equities are seeing major outperformance from financials / energy / materials / consumer discretionary sectors.
The timing of this is HUGELY important, because the past week’s VaR-based selloff was clearly driving an unwind of the mega six-month “cyclicals over defensive / bond-proxy / low vol” trade within the equities complex, which frankly has acted as a leading-indicator of “reflation”—well ahead of FX, commods and certainly rates. There had been a “risk unfriendly” rotation back into the “wrong kind of leadership” up to this point WTD: Utes, REITs, Healthcare, Staples and Telcos were 5 of the S&P’s top 6 performing sectors yesterday, for instance. Tactical ‘High Beta,’ ‘Inflation,’ ‘Weak Balance Sheet,’ ‘Size’ (small over large) and ‘Bottom-Quintile’ (worst performers) trades which had driven the MASSIVE performance catch-up (esp in Q3, where HFR Equity HF index actually outperformed benchmark S&P index, and HF VIP Longs were +10.2%, against SPX +3.3%) were showing signs of capitulatory unwinding through yesterday’s close.
So, we again get ANOTHER chance at perpetuation of the recent regime, where inflation expectations can drive the risk-asset narrative, and perhaps most importantly, re-price rates (especially the long-end / duration trade). Again, what is “mission-critical” then is the rate of change within rates—anything disorderly into the “fact of nature” that is the “short convexity” market structure we now operate within will continue to induce cross-asset volatility spasms (thus, the “long convexity” trade we saw yday in equities—a buyer of 150k Jan SPY 170 Puts—a 20% out of the money portfolio hedge and vol term-structure trade). Risk-assets can work if inflation AND growth are the drivers of said higher rates…but if it’s more “volatility spasms” which in turn cause systematic unwinds in a world very “long duration” (not just bonds, but equities too obviously!)…OR you get the inflation without the growth pick-up (a “stagflation” scenario), you then would see higher rates act as a headwind to stock valuation, as they suddenly look a lot more expensive per the equity risk premia.
Valuations Up 55% in Past Five Years…Five Reasons They Should Go Even Higher:
S&P 500 multiples are up 55% over the past five years, increasing from 10.5x to 16.2x today. Not surprisingly, many investors now question the sustainability of P/Es. Below are five reasons we believe they should drift higher:
1. Cash Flow Generation: Companies are generating 20%+ more free cash flow from every dollar of earnings (FCF conversion). This should push P/Es commensurately higher.
2. Return of Capital: The Total Yield (dividends + buybacks) of the S&P 500 is 4.7% versus 4.4% for a 20-year corporate bond. Stocks are extremely undervalued on this and other relative yield metrics. Further, the return of capital is 100% covered by free cash flow.
3. Volatility: Realized and implied volatility have been running ~30% below normal. This should equate to a similar reduction in equity risk premia.
4. Valuation Trends: Equity valuations tend to move from low to high (and back) over very long periods, similar to a slow-moving pendulum. With multiples well within a normal band, the current swing higher appears far from over. (See Exhibit 1 below.)
5. Few Excesses: Stocks are most likely to correct when some group is unreasonably priced. With the exception of Energy, whose multiples are elevated due to falling oil prices, there appear to be few excesses (yes, this would include Staples).
The deal was publicly announced in June, but Bed Bath & Beyond BBBY0.73% only would say that the “purchase price was not material” to the company, which currently has an enterprise value of around $7.6 billion. One press report suggested a price tag south of $30 million, but it seems even that estimate was way too high.
What Bed Bath & Beyond actually paid underscores how far One Kings Lane fell below investor expectations.
One Kings Lane was launched in 2009 by Ali Pincus and Susan Feldman as a Los Angeles-based flash sales site focused on high-end furniture and home decor. It would go on to raise more than $200 million in venture capital funding, from big-name firms like Greylock, Kleiner Perkins, Institutional Venture Partners, and Tiger Global. Its final outside funding round came in early 2014, at a post-money valuation north of $800 million.
The $11.78 million price-tag is net of any acquired cash. Bed Bath & Beyond also said in its regulatory filing that the results of One Kings Lane’s post-acquisition operations have not been material.
A Bed Bath & Beyond spokeswoman has not yet responded to a request for comment.
NYSSA Conference – The NYSSA had an all star panel today for their Ben Graham Conference. ValueWalk attended the conference and below are our informal notes, Enjoy! At the bottom of this post are more notes on the Ben Graham NYSSA Conference for 2016.
Munger’s three words that keep him out of trouble: “and what’s next?”
In Brexit, seemed a lot of that there. Always think about what the long term “and then what?” and what that leads to. The members of the UK seem to have forgotten to ask this question.
Up until the past 3-4 months, I didn’t have a new investment since 2010. The ability to do nothing with a portfolio is vastly undervalued. For all those at bats you swing at, you have to pay the government 35% – or more in NYC! One of my main takeaways from Graham and Buffett was this ability – the ability to be inactive.
Capacity to suffer. We love family-owned businesses – ones that don’t bow to the demands of Wall Street who demand constant profits. 60% of our businesses are family owned. I love finding properly-aligned companies like this. They have a time horizon like ours – forever. This is because they’re multi-generational, they have no interest in activists. Buffett made his success on businesses like this – ones that can take bets others can’t take.
We also love businesses we can follow and understand – ie why a consumer would choose Jack Daniels vs Jim Beam. Makes it easy for us to do due diligence and help us understand pricing power.
Emerging market reach is another criteria. Ones that can reach growing parts of the world, favorable population demographics, GDP growth
Historically we’ve owned non-US businesses. “Americans often don’t have a clue” – (Russo asks the room how many people follow cricket – no hands go up) – “Local players have a big advantage here. Cricket has 1.7 billion fans!” 75% of the assets I see are in non-US companies.
Globalization is starting to go the other way. I had this as a tailwind for my career. Now you have Syria, Russia/Ukraine, Brexit – it feels like things are changing – it used to be that new markets would open up, new competition was welcome, initiatives like the EU blossoming… not the same feeling anymore
Q: How do you think about FX risk?
A: “We don’t seek out currency risk in making investments. We think over time as more capital and commerce goes into emerging markets their currency will strengthen.
Q: Thoughts on Buffett/3G?
A: Businesses don’t get as cheap as they used to because of 3G – they have a big cash cannon. Every company we’re involved in is nervous for the potential of 3G coming along. It affects the multiples we’re paying.
Q: Sell discipline?
A: “I sold several companies in 2006 – all family controlled, but they lacked reinvestment. H&R Block, International Speedway. Powerful franchises but they couldn’t go beyond our shores. In some cases, it was too late – they’d already made very bad decisions – I pulled back and redirected the capital to businesses that I think have limitless reinvestment. Global ones. Sometimes a business we own advances sharply and we sell it down to rebalance the portfolio.”
NYSSA Conference – Second panel: “Never Lose Money” – David Poppe, John Levin
To never lose money requires that you have the right basis in your stocks. And so you have to be patient. Most of us don’t have the patience to wait a year to buy a stock. You need an investor base that is ready for long periods of inactivity punctuated by bursts of activity. Many of us don’t have that – the average investor wouldn’t be happy to go two years without a single investment.
Sole decision maker model can be powerful but also can take you down the wrong path. Consistency of process and clarity of expectations is crucial to having a high-functioning team.
We try not to incentivize people based on how many of their stock picks get into the portfolio. Sometimes the right thing to do is to have less.
There’s a lot of smart people doing this now – way more than there used to be. We try and be humble about what our edge is. Expert networks have taken away a lot of the informational edge that firms like ours enjoyed. We spend a lot more time on qualitative factors than quantitative. Key example: runway for reinvestment. How long is it? This matters a lot more to us than what the firm’s P/E ratio is. If a firm has powerful brands then this generally is conducive to a long runway.
“Never lose money” is a process. As public investors we buy companies with incomplete information and so from time to time you will lose money. It’s about consistency of process. Know whether you’re a growth or a value investor. Buffett stuck to his knitting and was congruent with himself. Long-term capital is another significant competitive advantage.
The rate of disruption is picking up. Long term investing has gotten more difficult as a result. Any company’s competitive advantage can erode much faster than ten or twenty years ago.
NYSSA Conference – Third Panel – “Margin of Safety” – Leon Cooperman, Jason Karp,
Risk is the probability of losing money. I’ll take a volatile 15% return any day over a straight line 10%.
We have a stock selection committee – three senior people. They need to approve any idea. If the stock takes out the downside risk target – then the “cesspool committee” – yes, this is an actual thing – takes over and grills the analyst. Do we want to double down or sell? Usually if you like a stock at 10, you should like it more at 9 and even more at 8. Sometimes circumstances change though – we try and drill down and see if anything has changed. We look for 3:1 risk reward ratio.
Stocks are the new bonds. 65% of the S&P now yields more than bonds. In 1958 – that was the year of the yield reversal. Before that, stocks yielded more than bonds. In 1958 they started buying into total return. The market got repriced. Today we can find so many companies with decent yields and growth prospects – far superior to bonds. Market is fully valued but there’s a lot to do.
This is not a market where you earn 10-15% in stocks. 6-7% is fair. Play it safe. Stocks are still the cleanest shirt.
Income disparity is a huge issue. 45% of jobs in today’s economy will be replaced by automation
“Wall Street is in the midst of a very serious downturn”
“Every investment committee in America is meeting to redeem out of hedge funds.” Inevitable downward pressure on fees. But everything is cyclical. This all happened in 1970 – see Carol Loomis article “Hard times come to hedge funds.”
This will all change in the next bear market. Hedge funds will shine and people will realize the downside of passive management.
Buying bonds here is like walking in front of a steamroller to pick up a dime. You might get away with it but its very risky. Inflation benefits stocks far more than bonds – companies can adjust operating cost into their selling price. Bonds can’t do that. I think inflation is coming and rates will be higher three years from today.
Multiple kinds of risk: analyst risk, volatility risk, market risk. Analyst risk: most often used but least reliable…estimation of fundamental downside. Company XYZ should never trade below 10x this – and having lived through many cycles, your excel sheets are useless in times of volatility. It’s the lowest weight. Market risk – what has the stock done? Any stock that’s gone down 25% twice in the past 18 months…it’s common sense you need to respect that, clearly 10% downside isn’t a realistic estimate for market risk. You also need to respect option pricing and what that means for vol (vol risk = the third kind)
Analysts tend to overestimate upside and underestimate downside
In the markets – the last 12 months have changed a lot. I began as a quant. We have three quants at the firm. Their job is to find things that traditional fundamental analysts won’t find. We’ve widened our range of outcomes – as in, how much can this thing move while we wait for our fundamental thesis to play out?
Running high gross and high leverage is extremely dangerous right now. Stocks are having insane moves on little or no news.
All these funds and systematic quant funds are dangerous – they’re all linked to the same thing – vol. So they all take down gross at once and that exacerbates vol and it feeds on itself.
In the end, stocks do converge with their fundamentals, but the linkage in the short to medium term is very cloudy.
Example: we’ve been long AMZN vs. short big box retailers for 4 years. “My mom could’ve thought of this trade” – but the volatility over the past 4 years shook a lot of people out.
Our interview process – we take a close look at people’s pasts – CIA interview process. We want people who have faced adversity. The markets constantly tell you that you’re wrong and stupid and adversity is good training for that.
Demographics: most hedge funds don’t pay attention to these because you can’t make money on a 1-2 year horizon off them, but they are very obvious and easy to follow. And they are poor for most developed countries right now.
“Social media is the most dangerous influence on society today. Look at Brexit. This is helping Trump’s campaign and explains why he’s getting so many votes.”
Also more extensive notes on Leon Cooperman which is a NOT WORD FOR WORD transcription of his speech.
I’d like to make an observation to help every body… I think it’s probably more relevant to most of us in this room. When I look at the room, I see youngsters that are coming into the business, I see some senior citizens that pray they’re lucky enough to have retired…I see a number of practitioners.
I’m going to share with you just a thought— I’m very focused on income disparity. I’m one of these kids who made it big in the South Bronx…
Six months ago, I went to a seminar and the seminar was nothing to do with the investing business, but the entire seminar was called ’closing the gap.’ It was one hundred percent focused on income disparity and how to deal with it.
At the seminar, they had a futurist speak. Before I tell you what he said: I’ll quote Warren Buffett who said: ‘The forecaster of the future will tell you more about the forecaster than they’ll tell you about the future.’ The futurist said— his opinion was the biggest problem facing the economy in the next decade was that 45% of jobs being performed in the economy were going to be replaced by automation and there would be no alternative work for the displaced workers.
I went home that night and I thought about it— I recognized the potential significance for our industry. OK. And the significance is… passive asset management turnover rate is 3% a year. Active asset management turnover is approximately 30% per year. So if more money goes passive versus active, liquidity in the market is going to diminish because there’s less trading. And the available pool of commission dollars to support Wall Street firm is going to diminish…
Then you turn to the money management side, if active management is 1% or some variation of 2-and-20% within the hedge fund community and you get the index for 3 basis points, 4 basis points, if you’re an institution, maybe 20 basis points in you’re Vanguard, if you’re an individual.. there’s going to be tremendous downward pressure on fees.
Maybe some of the young people should look into going into different industries to go into because I think our industry is in turmoil. It’s very ironic because you’ve got [Hillary] Clinton and [Bernie] Sanders crapping all over us and they don’t realize Wall Street is in the midst of a very serious downturn.
And I think what’s happening in my industry, you know, right now, I have this perception, maybe it’s an exaggeration, but… every investment committee in America is meeting to redeem out of hedge funds.
The industry is breaking down into two categories
One you got he way of these quant traders, algorithmic high frequency traders. I’m not as knowledgable as I should be, but I’m generally in the view that it’s a giant case of front-running, in some cases.
Well, let me explain why I say that: I’m not shooting from the hip there. There’s a lot of good value added— these algorithmic guys are very smart people. The New York Stock Exchange allows these high frequency traders to co-locate next to the stock exchange to give them a split-second advantage over the execution of the public sectors’ orders. I asked a question of the president of the NYSE whose response wasn’t very comforting which was: ‘If we don’t do it, someone else will.’ Rather, than taking the position that it’s morally wrong and it shouldn’t be done.
One part of the industry that’s apparently really successful, which I’m too old and it’s not my skill set is high frequency algorithmic trading.
The other is to be a serious long term investor a la Warren Buffett, Ben Graham, and you guys. The problem with that if you’re running a hedge fund and you’ve got monthly, quarterly, or semi-annual liquidity to deal with, it makes you reluctant to go into things that are less liquid.
I’ve got a little bit of a luxury because 40% of our capital is inside GP capital.
The industry is undergoing a major change. The market that we grew up in, is not the market today— volker rule, dodd frank, discouraged brokers to carry inventory. specialist system demised, can’t understand for the life of me… eliminated the uptick rule enabled .. if it ain’t broke don’t fix it. sec not paying attention to deal with it in my option.
gotta be an investor today or a very astute trader.
I’m basically of the view that everything is cyclical. My fear is—I read an article , reread it, reread it. hard times come to hedge funds written by carol loomis. if you look closely .. written jan 1970. largest hedge fund was michael steinhardt..
The golden period
“The golden period for hedge funds was 2000 to 2007. They became the cocktail party talk. ‘What hedge fund are you in?’ ‘What hedge fund are you in?’ They were outperforming other forms of active managers…Then, all the sudden, 2008 arrives. In my opinion, hedge funds largely lived up to their representation.” the sp down 34, av down 16. down less than half the market.
a lot of withdrawals. hf industry shot themselves in the foot by gating capital.
more scary— hedge funds was not honor a high water mark, asset of the investor. for you to say i’m retiring. that was in 2008. if you’re running a hedge fund it’s very hard to keep up with an index. hedge funds have underpreforme.d my guess is its going to all change in the next bear market…may take a bear market to damage all this passive indexation.. people who say .. hedge funds will shine again
Wednesday June 29, 2016 8:00 AM through 6:00 PM
NYSSA Conference Center
Available as: Live Session Categories: Conference, Programs for Members, Value Investing
In this conference, we honor the legacy of Benjamin Graham, the founder of NYSSA. The theme of this year’s conference will be Margin of Safety and Risk Management and subtopics will include researchprocess and portfolio management in volatile markets.
Please join us on June 29th to hear some of world’s leading value investors discuss these timeless topics. Portfolio Managers representing more than $80 billion will speak at the conference.
8:00-8:30 Continental Breakfast and Check-In
8:30-8:40 Opening Remarks
8:40-9:40 Opening Keynote: Investing in International Equities Thomas A. Russo, Partner, Gardner Russo & Gardner LLC
Panel #1 “Rule No.1 is never lose money”, Warren Buffett