The Hun's Market Round-Up and Portfolio Update
It’s been awhile since I’ve written a more general analysis of the market. I prefer to write equity analysis pieces for individual companies, but these pieces might give one a misleading impression of my form of stock analysis, as I am more macro-oriented than I probably appear and I do not consider myself a Buffett-style investor, even if my value orientation is similar. Rather, I have always modeled myself more along the lines of George Soros.
Some investors describe themselves as “bottom-up” or “top-down.” I would say that I am both. I will pick macro themes and then start searching for companies to buy into based on those themes. But I also do “bottom-up” picks, as well if I can find very cheap companies out there.
My research strategy is a bit unique. On one extreme, there are the Warren Buffett-types that like to deeply analyze individual companies. On the other extreme, you have those who rely solely on quantitative models to pick their stocks. I’d say my approach comes somewhere in between --- I have a method of quick research and valuation that I apply, then from that, I might dig deeper into companies that look particularly attractive from my initial analysis. Then again, I might not. It’s a trade-off; I have limited time and the more of the market I can survey, the greater likelihood that I will find stocks that have high return potential.
I like to sector-buy when I see a particular sector that is severely beaten down, so you could say from that perspective, I am a “top-down” investor; but in the end, it’s always individual companies that interest me and I’m willing to wait for the stocks to rebound, even if it takes a few years. I’m also much more willing than most to jump out in front of the proverbial falling knives.
That said, here are my thoughts on some particular sectors and the overall market:
I have been buying into REITs since about March of ’09, when I first spotted Winthrop Realty Trust (FUR) and was absolutely baffled as to how a company with a large amount of real estate assets, a massive cash balance, and relatively low leverage could be selling below the value of its cash on hand. This got me interested in REITs and I ended up analyzing about 20-30 of them, eventually buying into Pennsylvania REIT (PEI), Brandywine (BDN), DCT Industrial (DCT), One Liberty Properties (OLP), Lexington Realty Trust (LXP), Glimcher (GRT), First Industrial (FR), and Hersha Hospitality Trust (HT) at various points. All of those have been huge winners, with the exception of DCT, which I have made more minor returns on. It was, however, probably the safest REIT of the bunch.
Even after a massive run-up in prices, I still believe REITs are undervalued in the aggregate. We can talk about falling real estate prices all we want; most REITs have a built-in accounting cushion, since their assets depreciate on the books, but generally appreciate in the real world. Even with precipitous declines in real estate prices, many REITs’ assets are still undervalued on the books. Moreover, most of them still have decent, if not good, cash flows. Remember, “earnings” for REITs are pretty much irrelevant because of the depreciation and amortization charges that do not reflect reality.
When the U.S. eventually merges GAAP with IFRS, it’s completely possible that fair value accounting will become a reality in the U.S. REITs will likely be the biggest beneficiaries of such a paradigm shift, which is yet another reason I remain bullish long-term.
However, my bullishness is tempered by the declining yields. It is inevitable as the market has finally started to warm up to REITs, the prices have risen, meaning lesser returns for investors. For this reason, while I still believe the sector is undervalued, I have stopped most of my buying into the commercial and residential REIT arena. The one exception right now is FUR, which I like because the huge cash balance should help position them to take advantage of depressed prices.
Though, I still believe REITs are a good buy if one does not own any; I’ve mostly stopped buying because they form about 35% of my personal portfolio and maybe 20% of the fund I manage. At this point, I feel as if I’m “full up” on REITs and it doesn’t make sense for me to continue buying in unless I see some very deep values again (or I stop seeing better value in the rest of the market.)
Small Commercial Banks
I started becoming bullish on small commercial banks around September and October of ’09. There were a handful of banks I was looking at and while I felt that some could potentially see major trouble, the sector in the aggregate was deeply depressed. Therefore, my strategy was to buy into a basket of about 15-20 bank stocks with various risk profiles.
The most successful buy in that sector for me thus far has been Green Bankshares (GRNB), which I was fortunate enough to choose to write an article on. One of the least successful buys in that sector for me thus far has been Hampton Roads Bankshares (HMPR), which I was unfortunate enough to choose to write an article on. My returns on GRNB have been around 100%. My losses on HMPR were maybe 20%. My views on HMPR have changed and I have sold out of my position with a loss.
The rest of my bank portfolio has been mostly positive, with sizable gains on Synovus (SNV), Savannah Bancorp (SAVB), Susquehanna (SUSQ), Whitney Holding Corp (WTNY), Citizens Republic (CRBC), and Western Alliance (WAL). My biggest losers (aside from HMPR) have been Riverview Bancorp (RVSB) and Sun Bancorp (SNBC). Overall gains on the bank portfolio have probably been around 30% - 40% since last November.
Right now, I am still extremely bullish on many commercial banks. One of the things I love about this sector is that there are so many companies; it will take a long time for the market to discover all of the good ones out there. I continue to find great bargains among microcap banks and I may write about a few more in the upcoming months. Even the big regional banks are probably still significantly undervalued, however.
Don’t misread what I am saying. Many, many, many banks will fail or be required to do extremely dilutive share offerings either in order to survive or to pay back their TARP funds. In fact, that’s the primary reason I’ve bailed on HMPR; I’ve become more skeptical of the bank as time has progressed and I don’t see them escaping TARP without a massively dilutive offering. I’m also disturbed by the fact that they’ve failed to pay out a TARP dividend twice now and have never filed their 10-K for 2009.
HMPR still might be undervalued even with all the negative events, but I now favor CRBC and a few other higher risks banks (which I will withhold for now, as I may continue to buy them) over it.
I was a big buyer of commodity stocks in late ’08. It’s one of the reasons my score on Motley Fool’s CAPS moved into the upper echelons and my returns on KaChing skyrocketed in early ’09. However, I have become increasingly bearish on particular commodities.
I am closer in agreement to James Chanos’ bearishness on China than Jim Rogers’ bullishness. My belief is that China’s GDP growth has been driven heavily by three factors: (1) heavy governmental expenditures, (2) distortive reporting, and (3) mercantilistic trade policies.
With or without retaliation against China’s mercantilist trade policies, the China real estate bubble may soon unravel. If the US does label China a “currency manipulator” and impose tariffs to retaliate, I believe that this could put China at risk of a severe economic contraction. This means that many commodity related stocks will get absolutely destroyed.
China is only part of the reason for my commodity bearishness. There are other dynamics, as well. There will be winners and losers in the giant energy paradigm shift that occurs throughout this century. I view coal as the biggest loser and even though cash flows are currently very high for coal companies, I would be very reluctant to invest in any company that has significant exposure to coal.
I’m bearish on Walter Industries (WLT), which has had a phenomenonal run over the past year, but there seems to be some major insider dumping going on right now. When you combine that with macroeconomic concerns, that’s enough to scare me away. If it continues to move upwards, I might even be tempted to buy put options on it. The same goes for Massey Energy (MEE), which also has an unsettlingly large amount of insider sells.
Aside from coal, I’m also bearish on copper and would highlight yet another company with large insider fleeing in Freeport-McMoran (FCX). I’m also somewhat bearish on gold miners, which seem to be selling as if gold prices have risen to $1500/ounce with no cost increases passed along to them. Peter Psaras’ recent article on Seeking Alpha highlights the fact that gold miners still do not seem to be producing much in the way of free cash flows, but are selling at relatively high multiples.
Energy & Utilities
Energy is becoming an increasing difficult nut to crack these days. We are at a crossroads of sorts and I don’t think too many people would deny that we will see a significant paradigm shift in the energy sector over the course of the 21st Century. But how will things change?
Bill Gates certainly sheds some light on the issue, with an excellently argued case in favor of nuclear power. Small modular reactors may very well be the future. However, I’d differ with Gates on one thing --- I believe geothermal may have a great future in the Western U.S., as well. I’d keep an eye on Ormat (ORA), which has been hammered recently. There are some other microcap players in this arena, if you’re willing to dig into them.
I’ve finally given up on Raser Tech (RZ); in spite of having the most interesting technology in the geothermal sector, the company has been run so poorly from a financial perspective, that I have completely lost faith in it. It was never more than a speculative pick for me, but I do think their technologies have great potential. It would be interesting to see if some savvy big-money investor tries to buy out the company’s assets on the cheap.
For the near-term, I like natural gas and nuclear power. I have bought into a few companies in the natural gas sphere over the past six months. My favorites have included Encana (ECA), Western Gas Partners (WES), Constellation Energy Partners (CEP). Plains Exploration (PXP), and Petroleum Development Corp (PETD); all of which I have bought into in some capacity.
It has been more difficult for me to pin down any winners in nuclear, however. The only direct play on my nuclear bullishness has been the severely beaten-down USEC (USU), which I recommended (but never bought) around $3.50. I’m more skeptical at the current price of $5.70.
I do like a number of utilities that are in the nuclear sphere, including out-of-favor Entergy (ETR) and Excelon (EXC). These also double as defensive positions since they pay out significant dividends.
Finally, I have mostly limited my exposure to oil as it moved above $75/barrel. I do like two offshore drilling service companies --- Ensco (ESV) and Noble Energy (NE). I have been long both in my personal account since last summer. Jamie Potkul lays out the long case much better than I ever could.
The Macro Environment
For the first time in awhile, I find myself a bit torn on the direction of the macroeconomic picture. Many people were calling for hyperinflation beginning in late ’08; I do not foresee that. However, my predictions in regards to inflation and interest rates are that a Federal pull-out from the housing sector will cause rates to rise some, but the Federal Funds rate will stay near zero for at least the next year; maybe 2-3 years.
Some other things to consider:
(1) We will see continued deflation in real estate and inflation in certain commodity sectors. This fits in with the idea of commodity scarcity. All the same, I see too many risks to commodities (as noted above) to feel comfortable jumping in on most of them (with some exceptions) right now.
(2) The Eurozone will continue to struggle and many European economies will continue to contract as governmental spending declines as a result of excessive debt levels. This could trigger more deflation in Europe. It’s difficult to know whether or not the Euro will survive over the next decade and what changes we will see in the US by 2020.
(3) China has a near-term potential for high inflation due to rapidly increasing money supply. This could end up being the event that triggers a broader crash; the Chinese economy has been sustained by smoke and mirrors for far too long and the Chinese have no choice but to raise interest rates right now, which is going to put the brakes on the economy.
(4) The U.S. will fare better than most of Europe. This doesn’t mean we’re out of the woods --- merely that we will probably prolong our pain further into the future than European debtors. Governmental spending will stay high, but tax increases could steadily chip into US economic productivity. It’s unclear to me what direction the US will go. I don’t think hedging one’s bets would be a bad idea. My best guess is that we’ll see moderate economic growth for a few years, before another (more minor) downturn. That view is subject to change, though.
Well, if anyone managed to read through all of that, I applaud you. That sums up my market thoughts for the time being.
Disclosure: Author is long on several of the positions mentioned in the blog --- most of which are explicited noted in article's text.