Market Commentary

November 1st, 2014

With October drawing to a close together with the latest round of Quantitative Easing monetary policy I thought it worthwhile to chime in with my thoughts.  The S&P 500 sits right about where it was at the end of September having taken a 9.7% swoon in the meantime.   This type of fast and furious movement is consistent with an unclear picture for future earnings combined with uncertainty around what the potential end of the Quantitative Easing era could mean for asset prices.   I remain sanguine on the outlook and have kept our portfolio's substantial short positions intact.   This looked great two weeks ago and today looks less so, but as a wise man once told me "the game is not over."

I know it has been a while and you are likely yearning for another dose of my Russophillic opinion, so I will not disappoint you with today's tangent of the day.

I'd like to acquaint you with the name Valdai, which is the name of the lake in the Russian heartland of Novgorod.   The lake itself is a nice place to visit in the summer but other than that it is unremarkable other than having been the sight of the first meeting of the Valdai Discussion Club which is a high-falutin forum for discussion of the place of Russia in the modern world.  It is the Russian equivalent of the Council on Foreign Relations we have here in the US.  Last week Vladimir Vladimirovich Putin hosted the club at his rapidly ageing Olympic facility in Sochi.   He gave a speech which went largely unnoticed in the western media which came as a bit of a surprise to me since the content of the speech was quite substantial and his delivery was very evocative of Winston Churchill's "Iron Curtain" speech which marked the beginning of the cold war in 1946.

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Putin outlined very clearly his perception of current geopolitics and laid blame squarely at the political elite of the United States.   He used subtlety, humor and vitriol in equal doses with dramatic effect as he made the case that a uni-polar global geopolitical world inevitably results in chaos and bloodshed.  If you don't want to read the whole thing, here are a few highlights.

...the uni-polar world is simply a means of justifying dictatorship over people and countries. The uni-polar world turned out too uncomfortable, heavy and unmanageable a burden even for the self-proclaimed leader..... we hear slogans such as “the homeland is in danger”, “the free world is under threat”, and “democracy is in jeopardy”  so everyone needs to mobilize.....appeals to a kind of ‘supra-legal’ legitimacy when they need to justify illegal intervention in this or that conflict or toppling inconvenient regimes.....Arbitrary interpretations and biased assessments have replaced legal norms. At the same time, total control of the global mass media has made it possible when desired to portray white as black and black as white.

Maybe the United States’ exceptional position and the way they are carrying out their leadership really is a blessing for us all, and their meddling in events all around the world is bringing peace, prosperity, progress, growth and democracy, and we should maybe just relax and enjoy it all?

If we do not create a clear system of mutual commitments and agreements, if we do not build the mechanisms for managing and resolving crisis situations, the symptoms of global anarchy will inevitably grow.’s turmoil will simply serve as a prelude to the collapse of world order.

He painted the US with perhaps the most vile of modern Russian analogies, comparing the post-cold war America's behavior with that of thenouveaux rich:

Pardon the analogy, but this is the way nouveaux riches behave when they suddenly end up with a great fortune, in this case, in the shape of world leadership and domination. Instead of managing their wealth wisely, for their own benefit too of course.

Mocked the United States repeated military forays into the Islamic world:

I never cease to be amazed by the way that our partners just keep stepping on the same rake, as we say here in Russia.

Then he waved an economic hammer of his own by putting America's reserve currency status in the mix. 

We already see that more and more countries are looking for ways to become less dependent on the dollar and are setting up alternative financial and payments systems and reserve currencies. I think that our American friends are quite simply cutting the branch they are sitting on. You cannot mix politics and the economy, but this is what is happening now.

Finishing off with a patriotic history lesson and a jab at the heart of the post-war institutions.

Pressure from outside, as has been the case on past occasions, will only consolidate our society, keep us alert and make us concentrate on our main development goals.

In absence of legal and political instruments, arms are once again becoming the focal point of the global agenda; they are used wherever and however, without any UN Security Council sanctions. And if the Security Council refuses to produce such decisions, then it is immediately declared to be an outdated and ineffective instrument.

The point of this tangent is that I believe quite strongly that the US continues to vastly underestimate Putin's Russia and her ability to impact the the pseudo-stability and apparent tranquility we have enjoyed here since the end of the cold war.   Putin means business and he is playing a long-game and when he makes a dramatic outline of his view of the world order as he did last week, it is worth taking note of it.

Swoons and Value

Now back to business, one thing that 9% market swings do is provide lots of opportunity to buy things at great prices which is what we did.  One area which has presented a lot of value are branded goods which has become an area of concentration in the portfolio recently.   The reality is that brands are built over many years yet the companies are managed by the quarter.  This leads to some big price changes which present us with opportunity.

There is a certain magic about being able to sell something for more than it costs to make.   There is a spectacular form of magic in being able to take a commodity like steel and turn it into an $18,000 motorcycle, or taking $25 worth of camel hair and fashioning a $3795 Coat .   Turning leather into a $1,600 handbag or $300 pair of soccer cleats is what capitalism is all about.  Whatever the uplifting magic of yoga pants is, the true skill of a brand owner is to sell lots of them at high prices over and over for a long period of time.  

Our holdings of Branded Goods companies include:

Coach Holding - The affordable luxury handbag maker has had some missteps in the US for sure, but the real story is in Asia where growth and profitability has been strong.   The over-emphasis of the US softness has made the shares attractive.

Adidas AG - Adidas was a casualty of the European sanctions against Russia, which happened to be their largest growth market.  This development together with softness in the golf market which affected their subsidiary TaylorMade caused the shares to retreat by over 40% and well into our attractive Price/Value range.

Lululemon Athletica - Turning recycled soda bottles into $200 sports pants is only one of their magical abilities.  (position sold today)

Harley Davidson - Management decided to increase production during the spring of this year in the hope of having a blow-out summer.  Turns out they are only going to sell 270,000 motorcycles this year versus their earlier expectation of 279,000.  Despite the fact that they are selling the motorcycles at higher prices and margins, the shares are priced 22% below their highs of the summer.   This is a brand that people tattoo on chests which is priced like an off-brand.

Quicksilver - Admittedly this one is a vastly more controversial name than the others yet with similar attributes but magnified in their scale.   Quicksilver is undergoing a rationalization of the way they do business and consolidating operations of what used to be pretty distinct operations at their core brands of Quicksilver, Roxy, and DC.   The share price is a shadow of it's former self reflecting legitimate concerns about their ability to execute.   At this point the company would be an extremely attractive acquisition candidate for someone like VF Holdings which is an outcome I view as likely.

Honda Motor Corporation -  We were able to buy shares of one of the great Japanese companies at under 10x this year's earnings and they are going to pay us a dividend of 2.9% while they continue to make money.

Bayerische Motoren Werke AG - I wrote a note a few years ago about BMW and the story has played out very well.  We were able to buy shares at a single-digit multiple of operating earnings.  My note is attached and the thesis remains the same.

Phillips N.V. - The Dutch lighting and medical goods maker we have owned before got caught up in the turmoil of the markets and we took advantage.

Unilever - The godfather of branded consumer goods which we have owned before came back to our price/value range and we reloaded.

Tesco PLC - The British retail giant has come upon difficult times with the entrants of new competition in many of their markets.   This has weighed on profitability and caused them to cut their dividend.   The resulting dislocation of the shareholder base away from income-oriented shareholders provided us an opportunity to purchase the business at an extremely attractive price/value ratio.
Here is the full portfolio:

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July 31st, 2014

Everything seems pretty normal here on Earth as the human race continues their habits of warmongering, defaulting, invading and crashing their airplanes unabated.  

Based upon the data I look at the world is in a financially tenuous and potentially inflationary situation.   My view is that the long-dismissed and often obfuscated concept of inflation is something that we are going to need to deal with sooner rather than later.  Overall current equity and bond price levels do not reflect an appropriate amount of risk in my view which is why we continue down our extremely conservative investment path and we have sold several stocks which had appreciated out of our value-range.  Recently we have had some opportunities to by a few stocks at prices that represent good value, companies like Hexcel, Quicksilver and Adidas.   It is also notable that among the stocks I value there are an increasing number which are beginning to be priced close to where I would like to buy them is growing.   I do not feel like we need to be in any hurry to buy anything, but we will be moving as the opportunities arise.  

One thing about markets is that when the wiff of risk is sensed they tend to adjust quite rapidly to the situation.  As the amalgam of proverbs goes; when good news is bad news, when fear replaces greed...that is when today's low is tomorrow's high, so sell Mortimer sell.

Today I wanted to indulge in a slight pre-tangent sidebar on the Ukraine where I believe some peacekeeping a la Russ (i.e. invading/occupying/liberating or defending) is about to get underway.   I spent almost a year of my life in Donetsk so seeing pretty horrific images of places I am familiar with is a little concerning and I believe that a more overt effort from the Russians to restore some order to the place is imminent.  I also believe that an overt move from the Russians would likely be less bloody than the current covert effort. The folks most likely to be upset about Russian tanks in Donetsk are the ones who live in Washington DC.

Tangent of the Day: Defaulting twice on the same bonds?.....has to be Christina

Christina Kirchner has now managed to default twice on the same bonds which should be some form of new record.   Argentina is now tied for 3rd place on the list of most defaulted nations in the past 214 years but it is special in many respects.  Many countries default on their debt during times of revolution or warfare, such as the Germans default in 1948 after losing World War II, or the multiple Spanish defaults after the brutal Bourbon period and loss of their slave-fueled Bolivar and Venezuelan cash-cow colonies.   Venezuela only existed as an independent state for 15 years before their first default in 1826.   Argentina is special though since they have shown a unique ability to default at regular intervals during times of peace and relative prosperity.  Their defaults take on the form of semi-repudiation, where they invent some reason post-facto as to why they should not be obligated to pay off their borrowing in full.   They seem to treat creditors like a piece of lomo on theparrillada.

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Creditor Asado

In the good old says sovereign nations who defaulted on foreign creditors were at risk by military invasion by the creditors.   The British, with their naval strength proved to be excellent collectors of debts, invading Egypt in 1882 after the Suez Canal Company got behind on payments to British bondholders including my former employer Robert Fleming and his crony Nathaniel Rothschild.  They went on to occupy Egypt until 1932 which was quite good for Imperial business.   The United States Marines were enlisted in 1915 to go collecting in Hispanola (Haiti) on behalf of the Bank of New York, the US occupied Haiti for the next 18 years during which time lots of bootleg Rum found its way north.

Credit tightening is not something that is just done by the US Federal Reserve, Mr. Market has been doing a fair bit of credit tightening of his own over the past six weeks and the equity markets have been largely unaffected.  Our portfolio remains short "junk" credit and short long-dated treasuries in addition to our core outright short of the S&P 500 as well as a smattering of "junky" companies like Hewlett Packard andAmerican Tower.   In the case of American Tower they have been able to manufacture decent looking earnings which are predicated entirely upon their continued access to debt capital to fund further acquisitions.   AMT is a sub-investment grade credit, and the change we are starting to see in the credit markets is likely in my view to have an effect on its equity as well.

Our strategy remains extremely conservative with a distinct short-bias to the portfolio.   It is notable that many of the stocks we have been buying are in the consumer/retail/apparel segments.   There is no strategic reason for this other that these are companies which have sustainable margins from strong brands which the market decided to price cheaply after recent results. Here is what we have been up to:


Adidas AG - Adidas had a pretty radical price adjustment after they reported results which showed slower sales growth than anticipated.  My belief is that Adidas is still improving from a difficult 2013 and with a stable of strong global branded products like theirs it is worth owning.  We paid EUR 59.58 for our shares which is less than 15x the EUR 4.00/share I expect them to earn over the next 12 months.   Additionally Adidas is now yielding 2.4% at our cost.
Coach Holdings - Luxury retailer which we added to our position during the recent weakness.
Quicksilver - Continued to add to our position in stock as well as the bonds, we bought the 10% notes of 8/1/2020 at $92.20 to yield 11.35%.
Hexcel - The carbon-fiber maker we have owned before and is a welcome re-addition, we have been going very slowly and will be hopefully adding to this position.
Harley Davidson - The iconic motorcycle maker which historically has been valued in the stratosphere due to the very strong brand recently came back to earth.


Ship Finance Limited - Reluctantly sold our position, realized a nice long-term gain.
CIT Group - Realized a nice gain after announced acquisition. 
Banco Santander de Mexico - A great story which worked out well for us, would love to repurchase at a more compelling valuation.

Sold Short

Barclays' 20+ Year Treasury Index (long TBT inverse ETF)  Both of these positions will benefit from tighter credit conditions and incipient inflation.
Barclays High-Yield Credit Index (long SJB inverse ETF)

Bought to Cover

Royal Caribbean - Squeezed out of this short position after they reported strong results, will revisit later.

July 17th 2014

What do Russia, Beech Trees, Malaysian Airlines, stagflation, ISIS, Christina Fernandez the Gaza strip, El Nino, Mexico, Ottomans and Bluefin Tuna all have in common?

The answer is not a lot other than that I have been thinking a lot about all of them.   Here is my perspective on each:

Russia, Beech Trees, Malaisean (sic) Airlines - While novels could be and undoubtedly will be written about the events of today my take is that the midair collision between Malaysian Airlines flight 17 and somebody's radar guided Бук or "Buk"  missile represents a vast complication of the civil war in Eastern Ukraine.   Complicated situations play to the interests of the chess players and history shows the world champion chess players since 1880 have nearly all been Russian (see chart below).   Even Bobby Fischer the American cold-war wunderkind was unceremoniously kicked out of the USA and had his passport revoked in 1978.

Many Russian words have found their way into the English lexicon over the years largely due to major political or military events and today is no different.   The missile system used to target the airliner is from a family of cold-war era weapons called Бук or "Buk" which of course means Beech Tree in English.  They don't look much like Beech trees but are tall and strong enough to convince someone at the Tikhomirov Design Bureau outside Moscow to name their system after it.

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Stagflation, ISIS, Christina Fernandez and the Gaza Strip

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I remain particularly sanguine about the outlook for equity prices for the same reasons I have written about before.   The data I see points to rising inflation (particularly at the consumer level), and stagnant economic growth.   Yes that's right, it's time to dust off that old word from the 1970's, stagflation.   Stagflation is an economic condition which altered the course of history several times.  After the oil price shocks and ultimate fall of the Shah of Iran in late 1978, the ensuing stagflation became a fulcrum of political debate which led to the Reagan-era and the end of the Cold War.

So what could Russia, Iran, energy and inflation possibly have to do with 2014?   Well here we are almost 40 years later still confronting these issues which surely should be well understood by now right?  Not quite.  The global financial system is awash with excess liquidity which will need to be removed very quickly to avoid a dangerous acceleration in the inflation rate.   Secondly, the last weeks have seen host of external changes happen around the world which in my view will have a stagnating effect on the global economy.   Not least of which is the rise of ISIS which has now established itself as a de facto state in the Mesopotamian cradle of civilization.

This brings me to my favorite formerly-hot world leader, the one-and-only Christina Fernandez de Kirchner of Argentina.  This week she was visited by Vladimir Vladimirovich Putin.  It has been a difficult few weeks for Christina after the US Supreme Court handed down their decision that she must in fact pay all of the money her country owes to bondholders back, but she clearly perked-up when Putin's Ilyushin-96 jumbo-jet touched down in Buenos Aries.   Leveraging her leftist charm she managed to wrangle a $3 billion nuclear reactor deal, a few helicopters and some gas field development funds.

It has been busy June/July for Analytic Firepower on the research side, yet remarkably quiet on the transaction side of things. We have not made many changes to the portfolio, other than managing the size and structure of our short positions.   These positions have been costly especially our larger ones, SPY and Restoration Hardware in particular.   We covered about half of our SPY short and replaced much of it with options.   Gary Friedman at Restoration Hardware seems to be wining the hearts and minds of Wall Street which put a lot of momentum into the stock and we covered our short in RH at a loss.


Quicksilver - A fantastic stable of brands which is in a period of transition and carries a high debt load.   I believe that the realignment of their inventory position is nearly complete and some multimillion dollar insider buys very recently suggest that the senior management agrees.   It will be a bit of a struggle for them for the next few quarters but the business was available at a price that compensated for the risk.
TBT - This ETF holds long-term treasury bonds short, and is very sensitive to upticks in inflation.  Our position here is an expression of what I believe will be accelerating inflation into the fall of this year.
Coffee (physical commodity) - Re-bought part of our long position which we had traded out of earlier in the spring during the Brazilian drought.   I believe that current crop estimates are overly optimistic and the building El Nino condition currently in place will have further detrimental effects on global coffee production during the next year.
Gold - Another investment intended to reflect a hedge against US Dollar inflation.
Lululemon Holdings - Our former short position which has decreased in price very dramatically, to the point where I see value.  The value of LULU is bolstered by the potential for the founder to take the company private.   A very supportive product ass well.

Finally, the tangent of the day today has to do with Mexico and the Bluefin Tuna.   Over the past week an enormous amount of Bluefin Tuna has appeared in our local offshore waters, more than I have ever seen in my 30+ years of fishing in the area.   Lots of high-quality fish spread out over a 400 square mile patch of the Pacific.  The only trouble is that most of this patch is inside the territorial waters of our neighbor to the south, Mexico.   On Monday the Mexican fisheries office, Conapesca decided to halt all Bluefin Tuna fishing within their territorial waters, which has had a deleterious effect on my weekend plans.   Yes these fish are certainly endangered, but they also pull hard and look great sliced up on a bed of rice.  If only the Mexican Government could be a few days slower to respond to the existential threat to the species which my baited hook represents my weekend would be complete.   If only the Mexican Government would behave like a stock market, which can be very aloof to reality as long as the greed glands are pumping.   As shown in the newspaper clipping below from the Financial Times almost exactly 100 years ago to the day.    The highlighted article speaks of the muted reaction to the news of the assassination of Ottoman Archduke Ferdinand in Sarajevo which of course was the tinder that lead to the first World War......we'll see....TD

May 27th, 2014

Fear not, this message does not discuss Russian politics.

The past weeks have given us some limited opportunities as a few of the stocks on our list have approached levels where I am comfortable buying them.   The broader indices have remained near their highs which has been frustrating given our substantial short position in these indices, primarily the S&P 500, which we have trimmed slightly to control risk.  Overall it has been a lot of back and forth in the markets and I have constantly been reevaluating my thesis to see if any of the assumptions have changed, broadly they have not.  I thought it might be worth briefly outlining the thesis that drives our current positioning, then I will slide gracefully into the tangent of the day.

I believe there are a variety of factors which are causing investors to confuse the concepts of price and value.
  • We are in the latter innings of the financial experiment in the USA called Quantitative Easing, and the accompanying Zero Interest Rate Policy (ZIRP).
    • ZIRP has had a "crowding up" effect on share prices, since investment alternatives to stocks provide little return.
    • ZIRP has made capital available to large companies very cheaply.  They have borrowed heavily to repurchase their own stock which indicates their business opportunities are limited.
    • The transition out of this experiment is fraught with danger, one that even the most learned policymaker is unlikely to navigate easily.
  • Global geopolitics are in a phase of elevated risk.  In fact I dare say that they are at the riskiest point in my lifetime.
    • Putin is gaining power instead of losing it, despite the dangling sanctions the west has puffed at them.
    • Putin would relish the opportunity to see the US economy weaken.
    • European elections show a strong shift to the right and ultra-right.  This is dangerous.  The resurgence of "protest parties" is not purely a European phenomenon, as we need to look no further than the Tea Party here in the US to see how this effects politics.
    • These risks are mitigated by Narendra Modi's election as Prime Minister of India.   This is a fundamental, tectonic shift for India and is much more important than most in the US realize.
  • Stocks are by definition risky assets, when I look at every investment we make I carefully evaluate the both the risk involved and the potential return.   
    • Current index levels suggest that the earnings growth in stocks is very secure and of low risk.  I disagree and feel that there are elevated risks to the earnings of US companies that is not reflected accurately in current index price levels, hence we remain net short.
Today we are going to have a double-tangent of the day.   The first one is a quick analysis of the signaling effect of large corporate share buybacks.   In the first quarter of 2014 the 500 companies in the S&P 500 index in aggregate repurchased a staggering $160 billion of their own stock.   This has a lot of implications which are worth understanding.   First off is the idea that share repurchases are not intended to "buy low, sell high"  in fact quite the opposite.  The reason is that in general companies raise equity capital by selling shares when they need the capital, and they repurchase shares when they havetoo much capital.   The decision to repurchase company stock is not generally the result of a deep valuation analysis, instead it is done as a means of reducing the number of shares outstanding to enhance the price of the outstanding ones.   It also has the convenient effect of increasing earnings per share as there are less shares outstanding.   As you can see in the charts below, in the depth of the financial crisis when share prices were at their lows, so were buybacks.   The last time buybacks were as high as they are now was 2007 when our mailboxes were full of loan offers ever day.

The second tangent has to do with Narendra Modi and the election of his Bharatiya Janata Party to a clear majority rule in India.   It is difficult for me to express in words how fundamental this election result is to the future of India and the world, so it is worth understanding.   Yesterday's inauguration in Delhi represents nothing short of a complete reboot of the traditional power structure of post-colonial India.  It is the first time since 1984 that any Indian party has won enough seats to govern without the support of other parties.  The long-entrenched political establishment in India is quite literally gone and India now has a leader with the ability to bring India quite strongly onto the world geopolitical stage.  For those who are unacquainted with how Indian politics used to work, the labyrinthine alliances and constantly shifting sands of political favor fed rampant corruption and hindered economic growth.....not much different that congress here in the US.    

Narendra Modi is not your everyday politician, he is smart, shrewd and most importantly Gujarati, which technically aligns me with him ethnically-in-law.   During the election his opponents portrayed him as an ardent anti-Islamic Hindu-Nationalist hell-bent upon nuking Pakistan.   Yesterday the Prime Minister of Pakistan Nawaz Sharif accepted Modi's personal invitation and attended his inauguration, this is the first time ever in post-colonial India that this has happened.   Narendra Modi assumes leadership of India as the world's 3rd poorest leader, with no car, $84,000 worth of bank deposits, and 4 rings he inherited that are worth $2,450.  (José Mujica of Uruguay and Nepali Prime Minister Sushil Koirala are ahead/behind him depending on how you see it).   

Mr. Modi's was born into the ritually lower-ranked Ghanchi caste (oil-pressers) and his name Modi makes him an OBC, or Other Backward Caste in the eyes of the Indian government.  The OBC term refers to socially disadvantaged castes, he grew up working as a chai-wallah, or tea-boy at the local bus station.  His arranged marriage was a disaster which he claims was never consummated and after 3 long years he left on on a walking pilgrimage around India, after 2 laps around the subcontinent he settled into his political career working as an errand-runner for a predecessor party of the BJP.  His politics are inclusive and libertarian, he is pro-privatization and anti-bureaucracy.   Modi is a tee-totaling vegetarian and maintains a frugal lifestyle with a personal staff of three. He is a revered orator, a workaholic and an introvert who writes Gujarati poetry to relax....a lot like me. I'll close this tangent with one of my favorite selections of Gujarati lyric:

જય જય ગરવી ગુજરાત ! જય જય ગરવી ગુજરાત, 
દીપે અરુણું પરભાત, ધ્વજ પ્રકાશશે ઝળળળ કસુંબી, 
પ્રેમ શૌર્ય અંકિત; તું ભણવ ભણવ નિજ સંતજિ સઉને, 
પ્રેમ ભક્તિની રીત - ઊંચી તુજ સુંદર જાત, 
જય જય ગરવી ગુજરાત.

The point of this tangent is that India is an enormous economy that has just elected a leader which is likely to deliver substantive economic development and global trade/investment.   A freely-trading India has not ever existed before and may not ever, but it is going down a path towards serious geopolitical clout so it is worth paying attention to.  I have spent a fair bit of time in India and traveled around Gujarat a few months ago, I found a lot of serious business going on as well as serious guards and some very serious bulls, so I am seriously bullish on India.

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Tangents aside, here is what we have been doing:

Bought Long

Sears Holding - We repurchased a 0.8% position at $35.46 after the market reacted poorly to some weak results from their Canadian operation.   Our investment thesis on Sears does not have too much to do with their Canadian operations and the sell-off gave us an opportunity to get our stock back at a nice price.
Frontline Holdings, the tanker company we have owned several times before.   Despite some decent improvement in tanker dayrates the market is unconvinced that Frontline will be able to mount much of a recovery and the shares are priced at a pretty distressed level.   This position has risk associated with it for sure, as this investment is primarily a play on a recovery in tanker rates, which has been taking shape over the past few months.
Coach Holdings - A stock we have owned before and became available at a very reasonable price.   Coach reported quite poor results in their US operations which sent the stock reeling from $50/share to the low $40's, we purchased a 1% position at an average of $42.8, which is under 12x what they will earn this year and a 3.2% yield. 
Ralph Lauren, another high-quality retailer that was caught-up in the maelstrom of fear around consumption and gave us a chance to buy our stock back at an attractive price.
Atwood Oceanics - A very interesting company with an extremely interesting valuation.  I have written up my research in a separate note which I will be forwarding separately.
Cheung Kong Holdings Ltd - A high-quality global conglomerate which occasionally is priced like a Chinese property company.  The reality is that Cheung Kong has sold off essentially all of their mainland Chinese property holdings.  They maintain a solid balance sheet and very profitable global businesses like Hutchison Whampoa and a host of telecom and technology businesses.
Lululemon Athletica - Lululumon is a very rare case of a company we have previously had a large short position in, finding its way all the way to our buy list and ultimately into the portfolio.   The reason is that the price changed radically.   This caused the value of the business to be well in excess of the price, so we bought some.   Last fall we sold LULU short between $66-$69/share, because we believed the operational challenges they faced over the summer would continue into the fall which they did.  We covered our short in December at $58.share after they reported that the operational issues had affected sales.   Since then they have installed their new CEO, who followed the time-honored tradition of reporting a horrible first quarter and blamed everything on the past management.  This gave us the chance to buy stock at $42.50/share.  With the operational challenges largely behind them they can get back to the business of making butts firm and I believe they can get get back on a growth path which makes the shares worth $55/share without being stretched too sheer.
CIT Group - The leasing giant we have had on the buy-list got to our price, so we initiated with 1% position.

Covered Short

S&P 500 (partial cover), we shaved a little bit off our substantial index short in the interests of risk management.   If market remains strong we will continue to cover to keep the position from getting out of hand.


VXX S&P 500 Index Volatility - The volatility we anticipated around the Ukrainian elections did not materialize, and this ETF is an expensive one to hold so we let it go at a loss.

Sold Short

Barclays High-Yield Bond Index (via SJB ETF)

Often wrong but seldom in doubt.....TD

April 25th 2014

Peacekeeping has more benign connotations than Invading does, but they both describe the act of political occupation.  “Special War” is a term being thrown around these days that refers to a means of accomplishing political goals using a combination of espionage, subversion, provocation and peacekeeping without actually going to war in a conventional way.  This is what is going on now and in my opinion we are well advised to get used to it, as it is how the world works now.   Creating a popular narrative and insuring that enemies are infiltrated and rendered incapable of resisting the apparent will of the people is vastly more effective than shooting the place up Syrian style.

Russian intelligence, specifically GRU--the Main Intelligence Directorate, is clearly pulling the strings in Eastern Ukraine.  Utilization of special operators to cause mayhem and weaken Kiev’s weak claim on the region. Masking the identity of its forces and clouding the possibilities for international denunciation, is a central part of the Russian strategy, developed over years of conflict in the former Soviet sphere-- as John Schindler of the "20 Committee" quite accurately  puts it.

So it comes as no surprise that Russia has really ratcheted up the rhetoric, Lavrov called Kerry up to give him the usual rag-dolling and Kerry didn't take the call...

"The planned on April 23 and 24 telephone contacts, Minister of Foreign Affairs of the Russian Federation Sergey Lavrov and U.S. Secretary of State John Kerry, unfortunately, did not take place for reasons beyond Moscow control."

It seems he was pretty busy...

So Vitaly Churkin (who is a very serious veteran of Cold War diplomacy and in my opinion a brilliant man) steps in and breaks out his copy of the UN charter, and opens it to good old page 51.....boom.....peacekeepers.....who would have guessed that?

Russian ambassador to the UN, Vitaly Churkin's announced that Russia could invoke Article 51 of the UN Charter with regards to Ukraine.

The Russian ambassador to the UN Vitaly Churkin has announced that Russia has the international legal grounds for introducing peace-keepers into Ukraine in the event of necessity. Churkin told Interfax:  'There are relevant norms in the UN Charter, Art. 51 of the Charter, which speaks of self-defense, and which we, by the way, activated during the conflict in the Caucasus in 2008," 

So given what I view is a highly dynamic and pernicious global geopolitical environment, how best to navigate forward in time and preserve and grow our clients wealth?  Here is what we have been doing, primarily selling.   I continue to believe that the West radically underestimates Russia and Putin's ability to cause substantive disruption to European economies.  It may not happen, but the point is that it could and as long as the risk of it is high, I'd prefer to watch from the sidelines.

The Managed Equity portfolios remain in a highly defensive position with an increased amount of net short exposure from my last update.

"But, but...the market is going up and everybody is talking about the money they are making...Ultimately the value of an equity security is a function of the future earnings of the company, so earnings and prices generally have a lagged correlation   Current market prices reflect an anticipated rapid acceleration in earnings which I believe is too optimistic, particularly in light of the geopolitical muck-slinging in progress.   I make a great effort to interact with managers and owners of a variety of businesses and I have not come across a single one who is seeing any kind of rapid acceleration in their business that is in any way proportionate to the valuation of their shares.

The current market in my view is reminiscent of many previous peaks, where the constant reinforcement of higher price levels leads to broad investor complacency.  There is an increased reliance on non-traditional measures of corporate success.  (number of users, total addressable market, and my favorite "potential market cap" or PMC for short)   I am here to tell you that equities are risky things and the higher valued they are the more risky they are, and all market caps have the potential to be zero.

GLD - Gold ETF
VXX - S&P 500 Short-term volatility ETF
S&P 500 Index May 9th $186 put options at $1.07

Union Pacific Coporation
Pohang Iron and Steel Corporation
Bank of New York
Itau Unibanco Brazil
Turkiye Garanti Bank

Sold Short
S&P 500 Index ETF 10% at $187

Below are just a few other tidbits I found interesting.....sorry for all the gloom but I perceive risk to be high for the time being and the returns available to equity owners are not sufficient by my analysis to justify the risk.   We'll see how this all plays out but that is where we are for now.

March 28th 2014

I know that 3 in a row on Russia/Ukraine risks monotony, but it's a place I know well and I think this is extremely important.  First is a reminder the axiom that if you can get something for nothing, you should.    Vladimir Vladimirovich Putin redrew a substantial political boundary without firing a shot.  It is extremely worthwhile to note that the first time in the past century this has happened, it is not even the second, third, nor fourth time.  It is the 5th time, and certainly not the last.

It is notable that this week marks the 160th anniversary of Britain and France’s declaration of war on Russia in what would eventually become known as the Crimean ça change!

In the 1850s, Tsar Nicholas I had expanded Russia’s domain into Ukraine and Crimea, this irked the Imperial European powers of the day.  The British (Victorian) and French (Napoleonic), and Ottoman eras of expansion were taking their tolls and were in obvious decline. By 1854, the Ottoman Empire was only a few years away from outright default, and France was desperate to regain some of its geopolitical glory from the previous century.   So what better distraction from reality than pouring 1,000,000 youngsters into Crimea (375,000 of whom are still their in vast mass-graves).  Sound familiar?

To make benefit of these cultural learnings from the 1850's, I believe that trying to push the Russians around is extremely dangerous and ignores some core realities:
  • Russians were reluctant to give up any of the territories of the former Soviet Union back in 1991 where they formerly had dominating influence.
  • Russia knew what it was doing in 1994 when it signed the Budapest Memorandum on Security Assurances, which allowed it to take over the 1,900 nuclear warheads that Ukraine used to have. The Memorandum is just that, a memo...not a treaty or an alliance, it is a memo in which Russia specifically left vagaries around what constituted aggression and respect for territorial boundaries.  In return they effectively disarmed their neighbor, the formerly 3rd largest nuclear power with the stroke of a pen and a few billion dollars from US taxpayers....brilliant.
  • Critical parts of WW II happened in and around Eastern Ukraine.  WW III?
US Government and IMF Funding Gazprom

Any financial assistance provided to Ukraine is nothing more than financial assistance to Gazprom, and effectively the Russian Government.   In fact there is an internationally enforceable agreement that exists between Russia and Ukraine that insures this.
This did not happen by accident, on December 24, 2013 Russia bought $3 billion worth of bonds from Ukraine  — in U.S. dollars, and governed by U.K. law making them subject to the exclusive jurisdiction of British courts. And most crucially, there is an clause in the bonds that has a direct impact on American taxpayers
Paragraph 3 (b) under Covenants:
(b) Debt Ratio:  So long as the Notes remain outstanding the Issuer shall ensure that the volume of the total state debt and state guaranteed debt should not at any time exceed an amount equal to 60 percent of the annual nominal gross domestic product of Ukraine.
So with current government debt hovering at $90 billion, and GDP contracting to $160 this year, has Ukraine sliding close to the 60% Debt/GDP covenant any new debt such as the proposed US aid or IMF loans, would immediately make Russia's $3 billion worth of bonds immediately payable.   It would also allow Russia to sue in the UK courts to sieze any funds controlled by Ukraine, such as the IMF loan.

Ponder This:

In order to better understand how the Russians look at this, ponder the map below which shows who was invading where in the Spring of 1942.  All the red markings on the left were occupied by Nazi Germany (including key parts of Crimea).  More blood was shed in this area between 1941-1943 than any other military engagement in the history of warfare, and that is a lot of blood.   So Stalin went characteristically ballistic in and around Stalingrad where the Soviet Army captured/killed huge numbers of Nazi soldiers in the turning point of the Eastern Front of WW II.

This is what Ukraine looked like in 1942, and each of these areas had swastikas hanging over the central square:


My point is that the politicians of the world would be well advised to delve a bit deeper into their history books before declaring the 1991 Soviet-era borders of Ukraine as being indelible.

Ukraine in 1740

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So with all that said I believe that geopolitics remain as fragile as I have ever seen them, and the incessant momentum which has driven the stock market for the past few years is showing signs of abatement.  The chart below shows the change in price of some of the biggest momentum stocks of this era over the past 6 weeks.  Finally as I have written before I believe that the share prices of nearly every company I have looked at reflect an overoptimistic view of their earnings potential.   Hence we remain extremely conservatively positioned, and have become even more so since I last wrote.




Sold Short

Finally, I leave you with a nugget of a poster which reads "Empire is Life" which was hanging this week in the Moscow Metro station "Keivskaya" which perhaps not ironically was built by Stalin to commemorate 300 years of Russian-Ukrainian unity.   
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March 7th,  2014

The word "Invasion" I believe is a pretty strong word to use when describing the recent events in Crimea.  I think of it more as a ReAnnexation, or perhaps even Reunification.....nobody got hurt and Russia has their Black Sea Fleet securely back under their control.  Win-win.  With a lot going on in the world we have been remarkably inactive with all of the transactions since my last note aimed at decreasing exposure to reflect my increasingly pessimistic view of stock valuations and geopolitics.  We have whittled the portfolio all the way back to a net-short position which is about as far in the bunker as we go.  More on that later, I want to get going on the tangent of the day:  Vladimir Vladimirovich Putin.

Vladimir Putin had a 16 year career as a KGB counter-intelligence operative, here he is in the summer of 1988 with the camera around his neck staging for Gorbachev.  I cannot stress strongly enough how little respect the man has for Obama.  Putin (and Russians broadly) view Obama as an effeminate weak pawn and they take a certain joy in watching him try to grasp a situation which Russians understand from birth.  The Russian language is particularly rich in its ability to concoct scathing insults relative to masculinity, weakness and racial slurs.  When you travel to Russia you will hear a very broad sampling of them directed at Obama in the taxi from the airport.  When Obama was first elected Russian commoners and intellegentsia spoke as if America had lost its collective mind. Putin’s has never tried to hide his contempt for Obama which has only become more obvious with time.  

Ronald Reagan on a trip to russia.: Did Vladimir Putin meet Ronald Reagan as an undercover KGB man?

Obama on the other hand spent 3 years as a community planner before entering politics.   I believe that if he is serious about confronting Putin over Crimea that Putin will prevail.   Vladimir Vladimirovich Putin views the world through a very different lens than Obama.  Putin's perception of the world is driven by his upbringing in the Soviet Union and "former" employment as a KGB operative.  Putin is a very serious cookie and he means business, especially when it comes to Crimea, it remains to be seen how strongly he feels about Eastern Ukraine, my suspicion is that Donetsk, Kharkov and Dnieperpetrovsk are next on his list, and I prefer to not own too many stocks when that happens.

Real Economic Impacts

I have first-hand experience dealing with the leaders of former Soviet states, so trust me when I say that if they want to take your stuff they will.  Crimea is a strategic piece of land that Khrushchev decided to call Ukraine in 1954 during a vastly more collegial Soviet era, there were no oligarchs, just hammers, sickles and spies.  I believe that the US should think very long and hard before sanctioning Russia for re-annexing a piece of land that over the centuries has belonged to the Cimmerians, Bulgars, Greeks, Scythians, Goths, Huns, Khazars,  Kievan Rus', Byzantine Greeks, Kipchaks, Ottoman Turks, Golden Horde Tatars and the Mongols with parts of it being controlled by the Venetians, Genoese, Crimean Khanate, Ottoman Empire, the Russian Empire as well as Germany during WWII, and even the British and French Empires each had a go at it.

Sevastopol is no stranger to military conflict as evidenced by the numerous cemeteries around town.  There are 25,000 British, 40,000 French, another 40,000 Germans and countless throngs of Ottoman Turks buried in humble mass graves there, resulting from both the Crimean War of 1854-55 and more recently the Siege of Sevastopol in 1941-42.  It is a heavily militarized area and there is no coincidence that the CNN crew is housed in Simferopol which is several hours down a windy coastal road away.

The Russians can play the sanction game at a whole different level, they prefer to confiscate assets, repudiate contracts and simply take stuff.   Exxon has investments in Russia worth hundreds of billions of dollars.  Boeing receives about 35 percent of its titanium from Russia and sells over $2 billion worth of jets to Russian carriers per year.  Same story with other titans of american history Cargill, Ford, General Motors to name a few.  The reality is that attempting to cut Russia off from the world is a lot like poking yourself in the eye.

Today the German stock market sold off by over 2% after Gazprom threatened to halt deliveries of gas supplies via Ukraine.  They have done it before and I have no doubt that they will do it again.   I do not believe that the political will is there in Europe to support a US-led conflict with Russia which jeopardizes European gas supplies.  

NATO is simply unwilling to fight it out over Crimea in my opinion which will leave Obama pretty lonely on his moral pedestal with some new Ukrainian leader.

The strong views I have about the real financial impacts of the escalating contention with Russia do not seem to be shared by the market.   In fact the markets are downright euphoric at the moment.   I believe that euphoria and havoc make for strange bedfellows, hence our very conservative positioning in the Managed Equity account.
Media preview

Here is what we have been up to since I last wrote:


Tesla Motors - Covered our short for a singeing $46/share loss. Painful medicine we had to take. 
SPY Puts  March 14th $185.5 puts for $0.81 each as well as March 22, $185 puts for $0.89 each.


Unilever - Shaved a bit off the position, still a 2% holding.
Whirlpool - Harvested the good gain we had there and to lower overall exposure to euphoric market.
Rockwell Automation - ditto
Conoco Phillips - ditto
Campbells Soup Company - ditto
Allegheny Technologies - ditto
Merck - ditto
Nautilus - ditto
Sears Holding - ditto
Hexcel - ditto
Coach Holding - ditto  

Sold Short

Nothing, as ears still ringing from TSLA......

February 21st 2014

Today we are publishing our update on Restoration Hardware, Fear and Loathing in Corte Madera.

At the risk of being overly cynical after last weeks "Tanks Rolling in Kazahstan" tangent, this week we observed the beginnings of civil wars in Ukraine and Venezuela.  While the US equity market does not seem to care much about this I think it should and it will.  In my view many of these things can be viewed as the rippling consequence of tightening credit.  In overly broad terms, when the easy money stop people generally want their easy money back, sometimes they will pick up a rock an throw it at a tank that is standing in the way.

Ukrainian Civil War

A quick dip into Ukrainian politics is today's tangent of the day.  I have spent a lot of time in Ukraine and it is an interesting place for sure.  It is one of the few places on earth where two countrymen can hold a conversation in two languages at the same time.   It is not uncommon for ethnic Ukrainians to proudly speak their language to an ethnic Russian (who generally considers Ukrainian to be a sot of Russian jive), and receive an answer in Russian.  If there is one thing I know for sure is that you don't stop a Ukrainian civil war with a few signatures on a piece of paper, sadly it takes something a bit more decisive. There are a lot of competing interests in Ukraine,  Russians and Ukrainians are just the tip of the ethnic iceberg that is modern Ukraine.  There are loads of Tatars (famous for their eponymous sauce), Moldavians (wine), Bulgarians (cruel Olympic Judges) and Hungarians (hmm..) scattered around all of whom found their way the territory from various shifts in the political winds.

The distinct division between Western Ukraine was basically annexed from Poland (thanks to Stalin) and the Eastern part which consists of formerly Russian lands (thanks to Lenin and Khrushchev) is very evident in the political landscape.   At a fundamental level the current conflict is trying to resolve the question of whether Russia or Europe will form the core of Ukraine's geopolitical soul. Despite news of a cobbled peace deal and reversion to the 2004 Constitution we have not heard the last of this story.  The revolving door of former Soviet prisons will continue to spit out former Presidents and Pussy Riots.

Inline image 1Inline image 2

Our activity during the week is primarily intended to capture and defend the pretty good gains we have had this year.   We have shifted our volatility position to be long volatility as the price of insurance has come off significantly as markets resumed their complacent blissful upward glide.  The core longs of our portfolio are performing well most of what we are doing is to protect it in case of havoc.  I have included the whole portfolio below.

Here is what we have been up to:


VXX S&P 500 Volatility ETF (2%)
S&P 500 (SPY) $184 Puts 2/28/14 - Rolled forward our insurance.  This week we paid $0.77/share (0.0023%) to protect 50% of the Managed Equity account for next week.

Bought to Cover

VXX Options (all strikes we had sold)


Coffee Physical Commodity ETF (JO) - Took a nice gain after Brazilian drought fears got the price moving pretty substantially.  I still think that the global coffee market is going to be under-supplied next year and the market will need to find a new level, but we took our gains for now and will be keeping an eye on it.

Sold Short

S&P 500 ETF (SPY): We continued to take on lots of ballast and now have a 20% gross index short position, as well as options on another 50% of notional value.
Tesla Motors - Added to this controversial name during the week, and it is only 5 points away from our stop-loss at $215, so we have some risk here but keeping a tight eye on it.

In total, here is what the Managed Equity Portfolio currently holds:

Inline image 3

February 14th 2014

The tanks are rolling in Kazakhstan, London is underwater, California has a drought, Brazil has both heat-wave and a drought and every broker on the planet is recommending that you buy we go....I've kept this one short.

(n.b. my update on Restoration Hardware entitled Fear and Loathing in Corte Madera is still being worked on and will be sent separately but we have been pretty aggressively shorting this stock by adding to our existing short and buying put options.  I hold a very dim view of the outlook for RH.)

Things changed a lot this week, stocks came roaring back and volatility cratered.  We responded by selling stocks and buying volatility.  We did this by covering most of the short VXX calls we had sold (not that long ago), and buying puts on the S&P 500 and Russell 2000 indices in addition to a few individual stocks which are listed at the end.  It seems like every week we are making a tactical flip-flop, but it has been the right thing to do as markets have moved pretty substantially in both directions.  I believe this type of environment will be a hallmark of 2014.  It is a bit too much tactics for my liking, but for now it is working.

Inline image 3

The first picture above was taken on Thursday by a friend of mine in Almaty (the former capital city which used to be called Alma-ata, a name which rolls off the tongue in Russian, but always sounded weird in the Kazakh language because it translates to "Apple-daddy").  As the global credit slush-fest tightens and the effects continue to impact the fringe first, the Kazakh Central Bank on Tuesday devalued the Tenge by 20%.  Much of this was necessary to stem outflows especially with the highly correlated Ruble already having already lost 15% against the dollar in the last few weeks.   None of this has been lost on the local population who seem to be having an increased level of humor-failure associated with their diminished purchasing power.   Hence thetanks in the streets, we'll see how this ends.  In the meantime...

Get Me In!!

Behold a summary graph showing the investment recommendations from the leading investment firms on Wall Street.  They are pretty much unanimous that you should be buying stocks and selling bonds right now.  In my experience unanimity of opinion can lead to peril, just ask any surviving ferret.   Hence our pretty substantial ballast-shifts during the week.  (covered our SPY short on Monday and replaced it with IWM and SPY put options on Wed/Thursday)

Displaying groupthink_0.jpg

Қош келдіңіз Adolf

So a very quick tangent of the day today: Central Asian politics and name changes:

Central Asia is a place quite familiar and dear to me having spent the early years of my career camped out there.  They have a great propensity to rename almost anything as the political winds shift.   I once had a driver whose given name was Adolf.  Adolf was born in Eastern Poland in 1939 to some confused parents who apparently thought it prudent to have something kinship with the invading army.  

The president of Kazakhstan decided this week to rename his entire country to "Kazakyeli."  Clearly the "-stan" suffix was bad for business so they are replacing the Farsi-based ending with a more Turkic equivalent "yeli".  Still means the same thing "land of" but will finally complete the divorce from Borat associations.

The tallest mountain in the area started out as Mount Garmo, then a brief tenure as "Stalin's Peak", to the more prescient "Peak of Communism", and for now is referred to as "Ismoil Somoni" named after the folk hero du jour.  Astana, the new capital of Kazakhyeli was called Akmolinsk until 1961, Tselinograd (which means "Ambitious place") until 1992,  Akmola until 1998, before settling in as Astana.  Yikes...enough factoids...

Here is what we have been doing:


Lowes Corporation (L):  Not the home improvement company, but the high-quality insurance and oil conglomerate that reported earnings that seemed to confuse the market with weakness in their core insurance segment.  This was compounded by ongoing negative sentiment in the offshore-drilling equipment market which Lowes is active in via their subsidiarly Diamond Offshore, which has been weak.  The stock reacted pretty sharply and fell into our buy-zone so we bought 1%.

Standard Bank of South Africa:  Added another 0.15% to our existing position.
Chueng Kong Holdings - Added anther 0.75% to our position which is now 1.5%.

Everest Re Holdings: An enormous reinsurance company that we have been wanting to buy for a long time.  Similar story as with Lowes, they reported confusing (but decent) earnings which were misunderstood and sent the stock down to where we wanted to buy it.

Put options on SPY and IWM Index ETF's, late in the week to replace ballast after substantial moves.

Covered Shorts

SPY: We covered this tactical short on Monday as the market switched into go-mode and ballast became a nuisance, but as of today (Thursday) we had replaced the outright short with Put options.
VXX Call options, we covered all our $44, $45, and $46 strikes for nice gains, still short the $47 and $50 strikes, but overall exposure is 1/4 of where it was last week.

Sold Short

Restoration Hardware:  The stock is extremely overvalued and having a hard time selling existing inventory, full details in Fear and Loathing in Corte your inbox.

Tesla Motors - This is a controversial one that has been very strong but is likely to run out of gas/charge very soon.   A real momentum-oriented name with nonsensical valuation due to cultish nature of the shareholder base.   We are keeping this one on a tight leash with a 7.5% stop-loss at $215.

February 7th 2014

We were particularly active this week as we wrestled Dr. Havoc.  It seems that humans' fear and greed glands are both in overdrive at the moment which provide us with a lot of opportunity.  In the wake of Dr. Havoc's schizophrenia we made a few substantial tactical moves, first by covering all of our Russell 2000 Index short position, and secondly by adding to our short volatility position. On Friday (today) we sold a few SPY short to reintroduce a little bit of ballast in the portfolio for what is likely to be a choppy environment.  This week's tangent is a bit on the dry side, but if you read the whole thing you will be rewarded next week with the more salubrious Fear and Loathing in Corte update on Restoration Hardware.

This weeks Tango reference sadly takes us away from Argentina and instead directly into the Tangent of the DayHow/Why/When do we sell short volatility?  (this part gets a bit dry, so feel free to skip down to the CruciVXXion section for the fun Tango stuff).  

Volatility is a rather abstract measurement of how much something changes or will change over a specific time period.  There are a variety of ETFs out there that attempt to provide exposure to it.  The trouble with any measurement of volatility involves the time dimension which makes the whole concept rather fleeting.  Measuring volatility in the past is pretty easy since we can see what actually happened over a certain period, but evaluating it in the future is extremely difficult.   This is where the futures market comes in.  VIX futures make it pretty easy to observe what the market is anticipating the volatility of the S&P 500 to be over certain periods in the future.  

The value of the VIX future represents the markets' belief of how much the index is likely to vary before expiration, quoted as a standard deviation.  (to be precise it is the square root of the par variance swap rate for the term of the contract--but you do not need to remember that).  The important thing is that when Dr. Havoc is doing his thing the measure increases very substantially for short time periods as people fear the immediate future.

So what is a CruciVXXtion?

A CruciVXXtion occurs at the point in time when fear turns to greed.  Fear emerges from tumult, and greed is a primary driver of hunter-gatherer's behavior under normal conditions.

VXX is an ETF which attempts to replicate exposure to 30-day VIX futures.  It does this in a pretty simple way by daily buying a proportional amount of the second-month future contract and selling the front month to maintain a theoretical 30-day exposure.  Most of the time the longer future they buy will be more expensive than the shorter one they are selling, this buying high and selling low is a really bad business, but maintaining  exposure to volatility over time is a "high-rent" operation.  Rent is the value that is destroyed by this fund most days and represents the cost of maintaining exposure to volatility during normal periods of contango (where longer futures are priced higher).

In times of fear this flip-flops and the price of the front month is higher than the second month, meaning there is negative rent (aka positive carry) on a volatility position...this is a rare situation that only occurs for short periods, hence it is aptly called backwardation.  Invariably with the passing of time the fear subsides and greed takes over again, this is when we have a CruciVXXion.

The charts below show how this played out this week when we had an almighty cruciVXXion.  On Monday the downward sloping blue line illustrates the backwardation.  The current contango is shown by the red line.  There was lots of gore involved in turning the blue line into the red line....the mess can be seen in the second chart where the price of the VXX went from $55.22 to the current $45.02 and still falling like a soufflé .

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The strategy we use to benefit from this type of CruciVXXion is to sell in-the-money call options on the VXX which we did a lot of this week. 

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We also bought lots of stocks early this week when they were available at attractive prices, here is what we did:

Coffee ETF (JO): Ongoing drought conditions in Brazil have the coffee market in rocket-mode.  The coffee market has been oversupplied for years due to copius supply from Brazil.  This year it has been hot and dry in the main growing regions for the past 5 weeks and no rain is in the forecast for the next 10 days.  This comes at a critical time of crop development and this year is likely to be the first time the market has been undersupplied since 2009.  
Barclays PLC: Bought back some of what we had sold earlier.
Turkiye Garanti Bankasi: The biggest bank in Turkey which was being thrown out with the bathwater after the Turkish Central Bank raised interest rates.  After following this bank for 20 years, for the first time it traded at a discount to book value, and will still produce a ROE >12% even in a higher interest rate environment.  It is an extremely well managed bank and I am happy to have it in the portfolio for the first time in a long time. (.5%)
Coach Holdings: Another name we have owned before and were looking for an opportunity to get back involved and this week we got it. 1% position.
Allegheny Technologies: Our favorite specialty steel company, glad to have it back. (0.75%)
Grupo Financiero Santander Mexico- Added another 0.25% to existing position.  Go MexiTurkEa!
Hexcel: Carbon fiber and resin for composite materials maker.  HXL has long-term supply contracts to major aerospace companies and composite use is increasing.  HXL is the kind of business with a moat that we love, finally got a crack at it this week after it being on the buy-list for years. (1%)
Unilever: Added to existing position (now 1.75%)
Sears Holding: Somewhat controversial story which is centered primarily around the company's ability to monetize the value of their substantial real-estate holdings, the price was right this week.
Whirlpool: One of the great branded appliance makers in the US, a very profitable business with excellent cash flow and dividends. 1%
Cheung Kong Holdings, An enormous Hong Kong property company run by Chairman Lee Ka-shing, who is often referred to as the "Warren Buffett of the East."  It has been on our buy-list for a long time and happy to finally get some at a reasonable price.  They also own own 50% of Hutchison Whampoa, a huge global infrastructure company. 
Rockwell Automation: This is the well-managed maker of industrial automation equipment which we sold last summer and finally got a chance to get back in.
Nautilus: Our old favorite small-cap that makes and distributes branded fitness equipment. They are about to report their strongest seasonal quarter and the stock was on sale during the week so we got back in.
February $55 Puts on Restoration Hardware: Full details to follow next week in Fear and Loathing in Corte Madera.   Suffice to say that Polar Vortices & poor management does not help to sell $8,000 blank canvases.  All 10 of them are still listed as unsold on 

Inline image 6....10 of these are still available for $8,000 each.

Bought to Cover Short Positions:

Hong Kong and Shanghai Banking Corporation: It fell out of bed so we took our gain, we may revisit again.
Russell 2000 Index ETF (IWM)

Barrick Gold - Has been a great performer this year and as we made the portfolio less defensive we let someone else own our shares for a while.
Gold ETF: GLD: ditto

Sold Short
S&P 500 Index (SPY)- Late on Friday as market was a bit extended, a bit of tactical ballast as we come off a very volatile week.

Have a nice weekend and if you need some peace and quite just visit your local Restoration Hardware!!

January 31st 2014

Dr. Havoc got to work hacking his scythe around the world this week.  South Africa, Thailand, China, Turkey, Russia and other countries seemed to go into full-fledged crisis mode.    Happily the Managed Equity account was positioned well to endure it and increased in value over the week.   The account remains net short although we have begun to shift away from being short broad indices and replaced a portion of the shorts with individual companies which are unlikely to fare well in the coming year.  One interesting thing about crisis is that much can be learned about people by observing and analyzing their response to crisis, and this week was full of fireworks.  This of course leads us directly into the Tangent of the Day: The Difference Between Emerging and Submerging Markets.

Last Tango in Paris

Christina Fernandes de Kirchner is the formerly-hot president of Argentina who seems allergic to honoring financial obligations.  Her reaction to the tumult was right out of the time-honored Argentine playbook.  She devalued her currency, imposed restrictions on conversion of the peso and took off to Cuba.  Cuba after all is a favored destination of Mrs. Fernandez because it is one of the few places she can land her presidential airplane (referred to as "Tango-1") without fear of it being seized by creditors who are still irked from the $93 billion they are owed from the last time Argentina defaulted way back in 2002 under the stewardship of Mrs. Fernandez's deceased husband Nestor.   This situation sadly forced her to ride on a commercial jet in order to visit the UN last year.  In fact, she could not even take an Aerolíneas Argentinas plane, because she had just finished nationalizing it from the imperialist Spanish so it would have been seized as well. 

To demonstrate succinctly what I view is the difference between Emerging and Submerging markets consider a week in the life of Argentina's President, contrasted with the same week in Turkey.

Cristina Fernandez de Kirchner's busy week

1.) Devalue and restrict conversion of the Peso, 2.) Watch value of Peso plummet. 3.) Take Tango-1 for a spin up to Havana 4.) Make arrangements for a comfortable life in exile. 5.) Prepare for next default on the sovereign debt of Argentina.
Inline image 1File:Argentina Boeing 757-200 Tango 01 Transporte Presidencial 1 Lebeda.jpgArgentine President Cristina Fernandez de Kirchner (left) meets Cuba's former president Fidel Castro and his wife Dalia Soto del Valle (centre) in HavanaInline image 1

Meanwhile in Ankara...

The Turkish Central Bank also had a very busy week, but instead of implementing exchange controls, the Turks defended their currency by creating a financial incentive to hold Turkish Lira by raising their short-term interest rates from 7.25% to 12.5%.  A friend of mine in Ankara took the picture below which shows the lights on in the 10th floor offices of the Turkish Central Bank at 1:00 a.m on Tuesday as their policy response was being hammered out.  This bold move bolstered the value of the Lira and markets responded favorably.  The following two charts show the relative stability in the price of the Turkish Lira against the dollar, and the cost of insuring a Turkish 5 year bond against default.  Çok iyi bir iş Türkler!!  (Good job Turks)
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The point of this tangent is that I believe that 2014 will be a year of divergence where broad indices will have difficulty, but there will be lots of situations which present opportunity.  The good news is that this is the kind of environment where the fundamental work we do on individual investments tends to do well. 

We have utilized the current volatility cluster to begin to accumulate shares of good businesses in select emerging markets which became available at attractive prices.  We are primarily looking in what I call MexiTurkea which is comprised of Mexico, Turkey and Korea since these are three countries which are truly Emerging but get painted with the brush of broader Submerging markets such as those in Argadoristan(Argentina, Ecuador and Pakistan).

We have also begun to accumulate a larger short position in the short-term volatility tracking ETF VXX.  I have talked about the rationale before in previous messages, but the same theory applies that volatility tends to cluster and when you are in the middle of it it is a good thing to sell because it eventually passes.   We have done this by selling June calls on the VXX with strikes at $44,$45 and $46.

Here is what we did this week in the Managed Equity account:

Cemex - Sold to protect the large gain we had in the position.
Barclays (reduced position by 1/3)
Ambev - When currencies are being devalued, emerging markets consumer stocks can be tough and Ambev is no exception, will look to buy back at lower price.
JC Penney - I still believe it will work out, but in a market environment like this it's best to let someone else hold the shares for awhile.  We still own the bonds in the Cash+ account)
Russell 2000 Index (IWM) $114 January Put options:  These worked out well, we sold the bulk of them and exercised the rest, increasing our IWM outright short but decreasing our total notional short. 

Sold Short
American Tower REIT (2%) -
Royal Caribbean Cruises (1.25%)
VXX June $45 Call Options 

Grupo Financero Santander de Mexico (0.5% of assets)
Pohang Iron and Steel, Korea (Posco - Doubled our existing position)
Petroleo Brasileiro (added to our position)
Standard Bank of South Africa (added slightly to our position)

In the Cash+ Account we bought:

Republic of Turkey 07/14/2017 7.500% notes at $111.74 to Yield 3.77%
Advanced Micro Devices 6% notes of 5/1/2015 at $104.50 to yield 2.236%

I am pleased that the market has provided us the chance to begin to nibble at the crumbs which fall from Dr. Havoc's table.  This kind of uncertain market can be unnerving but it really is the mother of opportunity.  I intend to be extremely careful getting our large cash holdings to work, but this kind of environment is actually really good for what we do.

January 23rd, 2014

A lot going on these days as old Mr. Havoc seems to be lurking around every corner.  I am happy to report however that we have been actively preparing for him and are in a position to profit from his wake.  It seems pretty clear to me that we are beginning the cycle of credit tightening which will take some time to play out and present us with a lot of opportunities.  Taking a step back and looking at the current financial landscape there are pretty classic signs of change afoot in the financial environment.   
  • Clearly visible signs of price inflation (see today's tangent "No inflation for vegans")
  • High corporate valuations
  • Overly complacent equity investors
  • Weak emerging market currencies
As those of you who are acquainted with our investing style know, we do not buy or sell stocks "just because."  We go to lots of effort to have a solid basis for our reasoning before exposing clients to risk.  The highlights of this research are included in these emails which are intended to provide full transparency into the decision process.  It is our clear view at the moment that broad equity indices are expensive at the moment by any relevant measure.  Over the past few weeks we have made a diligent effort to get the Managed Equity account into a net-short position by reducing our largest holdings significantly, (including IBM which we were lucky to sell before their recent disappointing earnings) and by initiating a substantial (25%) Russell 2000 index short position as well as purchasing options on another 30% of the account value. This is a pretty strong tactical move which is exceptionally rare for us, this decision was not taken lightly and was the result of a lot of thought.

There has been lots of excitement with our short positions so far this year, with our largest short Best Buy (perhaps more aptly called Better Sell) taking a 40% haircut after reporting a horrendous performance over Christmas, we have now covered it and are moving on.   Restoration Hardware's silence about their holiday sales has been deafening and has kept the stock under pressure which we expect will continue.  In case you were wondering about how RH Contemporary Art is doing, they are now up to "Untitled #10" on the $8,000 blank canvas', and yes numbers 1-9 are still available also.  I interpret this to indicate that they have sold exactly none of

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Our long positions continue to do pretty well with the notable exception of our emerging market holdings (10% of portfolio) which have been weak as a result of currency turmoil. The good news is that we have enjoyed good exposure to gold and gold mining companies which have been the strongest sector so far in this young year.  Our largest holdings;Union PacificUnilever, and Cemex are all off to good starts as well with favorable earnings announcements and optimistic outlooks from management.  This of course means that it is time for the tangent of the day:

No Inflation for Vegans

The Bureau of Labor Statistics is in charge of publishing the Consumer Price Index which is broadly considered the benchmark measure of US prices.  The blue line below is the "Beef and Veal" component of the CPI, which theoretically should tell us how much the price of beef and veal is changing.  According to the government the price of Beef and Veal has increased just over 4% over the past two years.   However over in Chicago, the people selling cattle have had a different experience altogether.   If you actually want to buy a cow now, (intended) you will have to pay over 19% more than you would have two years ago as depicted in the brown line which shows the change in Live Cattle prices over the same period.Inline image 7

Similar anomalies can be found in other areas of the BLS statistics and it is pretty well understood that most of what the BLS puts out is actually BS.   My point with this tangent is that yes inflation seems tame, as long as you are a homeless Scientologist vegan.  Without food/clothing/shelter expenses it is difficult to experience inflation.   We all know intuitively how much these costs have increased recently.  This is the inflation that really exists and will increasingly become the focus of monetary policy.

A lot of activity in the past few weeks here is what we have done:

Reduced our holdings in:
Union Pacific, Broken Hill Properties (BHP), Cemex, Unilever

Sold our positions in:
Credit Suisse, IBM, Callaway Golf, Deutsche Bank, Maxwell Technologies, VXX, British Petroleum, Nautilus

Covered our Shorts in:
Best Buy

Sold Short:
Hong Kong and Shanghai Banking Corporation
Russell 2000 ETF (IWM)

Added to our Long positions in:
JC Penney 
Gold ETF (GLD)

Finally, I find this chart very interesting so I thought I'd include it, it pretty much speaks for itself:

January 10th, 2014

Here is how the Managed Equity account performed in 2013:

Inline image 2   (Note the out-performance in 6/9 months and loss avoidance in August and June)
*Date of inception 4/15/2013

It's a new year and here we go.  I am back from a great trip to India and the Middle East (and Mexico briefly) which provided some interesting fodder for our evolving investment outlook, which I'll get into shortly.   I thought we'd start the year up with my once-per-year appeal for new assets and referrals to people who might be able to benefit from the analysis and work that we do.   I only do this once a year so please bear with me.  

Coming up with well informed viewpoints with thoughtful analysis and expressing it effectively in a securities portfolio takes an enormous amount of effort and experience.
I devote an enormous amount of time and energy managing the client portfolios I mention in this regular e-mail.  Doing this all comes at a pretty substantial cost to me and this far it has not exactly been a profitable undertaking primarily because of my low-fee structure (0.75% per year) which is about half of what traditional managers charge.   I enjoy doing this work very much and I would be extremely happy to continue plodding along at this for the next 30+ years if I can start to leverage the costs with some volume of assets.  The simple fact of the matter is that I need to increase the amount of assets I manage if I am going to be able to continue to devote all of my time and effort into this process.  So please take a moment to think about people you know who would benefit from having our work applied to their assets.

This is where you and your networks come in.  I have two primary strategies which I manage and I refer to in these communications, the flagship is theManaged Equity account which has all the best ideas included in it.  The current portfolio is included below, and in general it is a mid-to-large cap equity long/short portfolio.   Every single investment is the product of the diligent independent research process I undertake, which I can conclusively assert is vastly more rigid than 99% of the other advisors out there who charge a lot more and do a lot less.   The mechanics of getting started are incredibly easy, all it involves is assigning our advisor code to your Etrade account (or opening an etrade account which takes about 3 minutes on-line).  You will receive all confirmations and statements directly from Etrade where your assets will be held in their custody, and you can add/withdraw assets at any time exactly as you would any other Etrade account, at the end of the month they will send me 0.0006 (six ten-thousandths of the value of the account) (0.75%*1/12) which will help me keep the lights on (and the kids fed).

The second strategy is the Cash+ account, which is a short-term fixed-income strategy.  It came about as clients needed some form of alternative to zero-yielding cash.  The Cash+ account holds bonds of both investment grade companies and those which are slightly below investment grade with regular maturities which are all less than 3 years in duration hence it has very low interest-rate sensitivity.  The portfolio currently yields 2.83%.  It is intended to be a parking place for assets which will be re-invested in something else over the coming 2 years as interest rates begin to rise.

Now with that out of the way, here's what we've been doing:
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Before the end of the year we realized essentially all of the losses we had on positions to offset part of the pretty substantial gains we had realized during 2013.  This involved covering our sizable short position in the S&P 500 we had been wearing as a hedge.  This leaves us a bit more exposed than we otherwise would like to be, however overall still pretty moderately invested with 44% of the account in cash.  I had the chance to speak with all of the clients at the end of the year we will be heading into the first part of the year hedge-less in most accounts.  This rather conventional approach for now is rather uncharacteristically mainstream, which is to own good companies and not be overly clever with the short side.  There will be plenty of opportunities in the coming year(s), and we are well positioned to be able to benefit from them as they arise.   

My expectation is that this year the dominance of the US Central Bank's grip on the capital markets will begin to wane, which thankfully will have the effect of rewarding the kind of fundamental work that we do.  To borrow an analogy from Warren Buffett, if the tide of liquidity begins to go out, it will become clear who has been swimming naked.

Looking back on 2013 we had a good year which was punctuated by the tactical error of being hedged during the confounding post-summer, Syrian chemical attacks and US debt-default/governmental-paralysis-driven 10% ripper market rally during the seasonally hazardous October and November time frame.   Looking back on it I think we took a prudent course of action during a very uncertain time and we still managed to generate an 18% return in the 9 months we were in business.   If only every year could be like 2013.

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December 11th, 2013

Our old friend Dr. Havoc seems to be knocking at the door and frankly it is very nice to see him again.   Dr. Havoc is the proverbial drum-major of opportunity and generally speaking our style of research and investing tends to be rewarded when there is some uncertainty around.  The difficult question to answer at this point is how long will he stick around.   The portfolio is positioned pretty well to handle whatever the doctor has in his bag with moderate long exposure and a healthy amount of insurance in the form of put options.   We have not been very active in the past week with only two transactions in the Managed Equity (bought some JC Penny and sold some Restoration Hardware puts against our existing short position).  In the Cash+ account we added one bond at 0.5% size. 

CLEAR CHANNEL COMMUNICATIONS INC 09/15/2014 05.500% at 100.27 to yield 4.96%.   Clear Channel has a huge amount of debt which makes it a somewhat riskier proposition as far as the rating agencies are concerned which is reflected in the higher yield.  The good news is that the bonds we bought are the first ones that will get paid back.  Our bonds mature next September and the bulk of Comcast's debt begins to mature after 2016, so if all goes according to plan we will have our money back with interest well before Clear Channel gets into hot water.   
Here is where we stand overall at this point.  If things begin to unravel it is likely that we will become more active in particular by selling volatility in the form of options as we start to work down the buy-list of companies we want to own at the right price.  Should be fun.

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As if overall market volatility were not enough, we are pretty certain to see some action in the coming days as several of our large positions will be reporting earnings.  In particular on Thursday is a doublehader with Lululemon Athletica in the morning and Restoration Hardware in the afternoon.   The market is extremely lathered-up for the Restoration Hardware earnings, the at-the-money options are trading with an annual volatility of 103% which implies that in aggregate the buyers and sellers of options expect the stock to move around 13% in some direction as a result of the earnings.  Naturally we think that anytime someone is willing to pay a price that implies over 100% volatility for an option on a stock we have a position in, we take their money.   We sold some $60 RH puts that expire next Friday for $2.05 each, so if the wheels fall off the RH train in the next week, we will have covered 2/3 of our position at $57.95, which is just fine. This of course leads very squarely into Tangent Of The Day: Volatility and Time.

It is pretty common in times of turmoil and fear to see measures of short term volatility exceed longer term measures, creating a situation known asbackwardation.  Today we saw a pretty big shift in the term structure of volatility.  It gets a bit abstract, but suffice to say that big shifts in the relationship between short and medium term volatility is most certainly a hallmark of Dr. Havoc.  It provides a measure of how much people are willing to pay for short-term insurance as opposed to longer term.  Intuitively, insurance that lasts longer should cost more, and it generally does except when Dr. Havoc knocks, and lots of people try to run through the small exit at the back of the house.  The current level of backwardation between the December (spot) and January (future) volatility indices is at a level last seen in August of 2011 when the US Government lost it's AAA credit rating.

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For more musings on this tangent, here is a paper I wrote back in 2011, which oddly enough was exactly when the term structure was this backward for the last time.  


P.S. Heading off to India later this week so I'll leave you in peace next week.....Merry Christmas...