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After a difficult 6 months in SLO2 and in my personal portfolio, I take some comfort in reading the occasional article about various well-regarded and previously successful professional value investors who have experienced similar underperformance. The question comes up, why not switch over to something that works, like long energy and commodities and short financials and consumer discretionary?
With energy and commodities looking more and more like bubbles, and with financials wearily scraping out what looks like a deep saucer bottom, it doesn't make any sense to realize substantial losses on stocks I consider undervalued in order to bet the meager proceeds on companies that are cruising around in the vicinity of 52 week highs. Now would not be a good time to try the chameleon act.
On a more personal level, it's about taking the advice: "Be yourself." I attempt to beat the market by picking stocks, and I put considerable thought and effort into the process. My natural tendancy is to focus on value, and this occasionally leads me into contrarian positions. I admire John Neff, not for deep analysis of stocks or markets, but for the tenacity with which he held to to his convictions on value - an attribute which was key to his long term success.
My two best performers were Olin (OLN), in the basic chemicals industry, and BJ Services (BJS), in oil field services. Both of them increased about 50% after economic conditions in their industry became more favorable. BJS is very dependent on North American natural gas, and when that rallied BJS was carried along. I have sold off my entire position. OLN is in the chlor alkali business, which would normally be dependent on strength in housing and automotive. However, as the situation developed, caustic soda demand got tight, and OLN has a cost advantage over its competition because it is less dependent on electricity generated by natural gas. I have liquidated all but 300 shares.
My two losers were financial guarantors Ambac (ABK) and MBIA (MBI). Comparing myself to other value investors, they got burned on the likes of Washington Mutual (WM), National City (NCC), CItigroup (C), Fannie Mae (FNM) and Freddy Mac (FRE). I was tempted by some of the above, but with amazing perspicacity and fine-turned judgement I saw the declines coming and avoided them all. Leaving aside the sarcasm, I have been asking myself why if I could see the problems with banks, I didn't see them for the financial guarantors, and still believe ABK and MBI are good investments.
The answer is I was drawn to MBI and ABK because I spent much of my working life in insurance, understand the busniess, and have made money investing in insurance companies. After initially underestimating the complexity of the issues involved, I have developed a good understanding of the situation, and I enjoy keeping up with developments and blogging on the issue from time to time. I have a strong opinion, and regard the risk/reward as very favorable here.
As a practical matter, value investing will frequently leave the investor waiting for improvements in conditions in the economy, a specific industry, or company specific problems. The value may be there, but a catalyst is required - either a dramatic surprise or a long term change in perceptions or conditions. In my opinion, the current financial crises is largely a hysterical over-reaction - things simply are not as bad as the press and those who profit from the difficulties of others would have us believe. I can't predict how much unnecessary loss the current panic will create: so, I position myself to benefit if and when it abates, and I wait.
My thanks to all who commented on my blogs or corresponded with me, especially Russ, Don, Dave, Becky and Fernando. It's about companionship on a journey. I have been watching in wonder as FRE and FNM tank 50% - they have the dread disease - they "need capital." Do I dare to call a bottom?
Tom
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Comments (3)
Hi Tom, There seems to be a bit of stuborness among value fund managers like Weitz, Nygren, mille et al. I never understand why they don't have an exit strtegy and try to cut losses at say 20% loss of a holding.
What are your 5 top picks in the financials?
Posted by gullapalli | July 19, 2008 9:18 AM
fnm and fre are another $0 or $2 or whatever. I want to save you money here, dont go in your averaging down rampage.buffett sold his freddie stake in 2000, he was dead right, if you think dipping on a 130-1 on common equity levered company in the worst housing downturn in 70 years is value investing, I wonder what you think is speculation
Posted by tradingbr | July 25, 2008 6:32 AM
tradingbr,
Maybe I didn't express myself clearly in my post - I don't own any FRE or FNM either in SLO or in my personal portfolio. The thinking would be, the whole situation becomes a game of political football, as well as a morality play, and shareholders of FNM and FRE could wind up on the short end of it. Also, I have enough exposure to this housing situation already without adding to it via these two situations. My interest is whether the firestorm around FRE and FNM was a bottom for the whole market.
My doubling down rampage is limited to ABK and MBI. Developments over the past month or so are supporting my thesis, that these two are seriously, seriously undervalued by the market, in view of the present value of future premiums which are already booked and the expected reversion of mark to market losses which are not real. For MBI, it goes: book value, 8.70, adjusted book value (includes present value of future premiums) 26.67, analytical adjusted book value (which excludes mark to market losses) 42.15. For ABK, it goes: book value 4.52, adjusted book value 15.83, analytical adjusted book value 35.60. I will give you a 10% chance of zero, but would suggest you consider the 10% chance these will wind up trading at 42 and 35 respectively within two years. The most likely two year price targets would the the adjusted book value, 15.83 and 26.67 respectively. Shorting either of these at 2 or 5 is crazy.
I have carefully reviewed the Servicer reports as of 7/25 for ABK's problem HELOC and CES exposures, and note that losses are leveling off and the most recent month features lower losses than the three month average in 4 out of 5 cases. I note that median prices of existing home sales have risen for 5 months in a row. I note new homes continue to sell steadily at a voljume roughly 30-35 % less than last year. The ABX is starting back up. The "rescue" of FNM and FRE should be complete next week, which prevents the catastrophic downward spiral you appear to expect.
A while ago you were kind enough to suggest some protective puts on MBI which would have saved me a lot of money. Now I am pleased to reciprocate and suggest you buy some protective calls (if you must continue to short these two.)
I recently bought a very large number of the January 2010 2.50 calls for ABK at prices averaging .59. I am watching for a similar opportunity to develop on MBI. The plan is, after holding the positions long enough to get past the wash sale rule, I then sell some of my shares, which under FIFO accounting will enable me to book a large loss for tax purposes. Then, as the share prices recover, I will realize a generous profit on the remaining shares and the calls.
Posted by Thomas Armistead | July 27, 2008 8:13 AM