Posting this for completeness but please don’t bother reading
This is one of the foundational email chain between myself and a former colleague to my decision to start this publication. This person was of great influence on my thinking and approach to investing and had much more to teach me before I embarked on a globe-trotting journey for now 5 months as of the time I am publishing this note. I have made edits but kept the spirit proper to the conversation.
“Former Colleague“: Just got back from a short vaca to the mountains nearby. Not quite as adventurous as backpacking in Kazakhstan but the thrill of roughing it in the outdoors with a diaper bag on a 2hr hike must be quite comparable. I enjoyed the portfolio update. And here I thought you were only/mostly crypto.
I’m especially impressed, given you don’t have the 17 Bloomberg windows to manage your global macro port now.
“Yours truly“: Traveling the world is overrated. A mountain is a mountain is a mountain, so your mountain should beautifully fit within that construct. Glad you enjoyed the time off, and I’m sure it was very well deserved! Koyfin, Tradingview and the CME website are my new BBG terminals. Your impact and thought processes are always present, and worst of all, I have actually started assigning an IRR to some of my trades… I know, boring. Also, public markets have the beauty of public data. Nothing a couple of Python scripts (a few little lines) and public libraries can’t pull together to get a few quick macro dashboards to derive the wrong conclusion. Crypto has been reduced from 85%+ to a measly 20% of NAV, and I am fully ready to see it go to 0% (and not by selling it). Price action does not show it, but development on blockchains has blown up, which is very healthy for the ecosystem with many interesting use cases. For example, Hivemapper has mapped 1/5 of the world’s roads in a decentralized manner, capturing car GPS, people walking with their phones, and cameras. The train won’t stop here despite the sideways price movements, but I did need to diversify. A few odd lot trade ideas that don’t fit into the thematic framework:- CI Financial: Odd lot tender at 15.5 (entry 14.4) expires in a couple of weeks and is voided if stock, S&P 500, TSX, or Dow Jones decline 10% from the May 30 reference point. A quick trade with a non-zero chance of losing the 10% for the stop loss.- DOUG: Luxury lives forever. Look at the stock performance of ultra-luxury vs. semi-luxury (rich people spend more when inflation goes up). So what about luxury real estate? A few points: – 5th largest RE broker (with 22k transactions in 2023 at 1.6m average house price) – Higher rates have contracted home sales, but luxury homes have been less sensitive (all cash but likely borrowing against securities to fund, so some rate sensitivity) – Net income negative for the past 7 quarters and continued insider buying (I like companies managed by capitalists, not bureaucrats) – 25bn conso development with 5bn being delivered in the coming year – Starbucks gift card accounting: when a sale is made and the condo is not delivered, the cash received is a liability and should start being recognized as time goes by (I modeled it more or less linearly, not
clear around the exact timing) – Luxury real estate has a speculative component which the proletariat does not quite tap into (living in your house like a poor person?) So with market average, some 15-20% of those condos should be on the market for DOUG to double-dip on the fees and a pipeline of repeat business. – Their 34bn of transactions should go up some 10% next year just from this new vertical, and the luxury market has started inflecting where the proletariat market is still taking a breather. – Price to sales is 0.09. Based on multiple re-ratings (comping to others in the space for historical precedent in “good times” and quick math on revenue projections), it should be a 30% IRR for the next 5 years. Downside is the macro/rates story, so timing entry around rates is key.
Okay, let’s make this a bit more interesting and go to the uninvestable. –Anton Oil Field Services: (But not extraction, rather engineering and technical services for the drillers) – What do I like about it visually? It has moved sideways independent of oil price (even in weakness). Why is that good? It has managed to reduce its debt over the past two years and now sits on a healthy pile of HKD500m net cash with a net income of HKD215m. 60% of the business is outside of China in rapidly growing commodities markets (Iraq, Oman, Qatar, Azerbaijan, Kazakhstan, Egypt, Algeria, Nigeria, and Indonesia, Malaysia, and Singapore [coming up on the trip]) – This stock has great asymmetry but needs to be sized carefully, as the US has a habit of sanctioning random companies like Jutal Offshore, where I sucked up the 30% loss on a 50bps NAV position and was forced to sell the company. I won’t invest in enemies of the United States of America! Typically, I am looking for asset-heavy companies in cyclical industries that are starting to pop their heads after a miserable ten years. One way to put the energy trade which I am very much invested in currently, is that the “green” agenda is fundamentally antithetical to democracy, as the electorate will always choose cheap energy over sustainable energy. The only way to usher in the green future is with heavy-handed totalitarian reforms (not going to happen, or i hope not…). You see moves in Europe across all countries away from the center towards both ends of populism and not caring about what regulators think. Germany was supposed to lead Europe towards green energy, but when the Ukraine war started and worries about energy safety grew, they managed to build an LNG import terminal, which “experts” said would take 5 years to build, in just 10 months. The West chooses to be inefficient but can be brutally “Chinese” in their execution of essential tasks when they want to. Long story short, the path towards the green transition can only go through traditional energy markets. Long live the green transition, long live fossil fuels! Cheers and hope to see you pronto!
“Former Colleague“: As the worst performing sector of the S&P, there are sure to be oversold names in energy. REITs too (many at least screening cheap). So think you’re focused on a lot of the right places. As for DOUG, beware of the value trap. Though insider buying in small caps that are down 50% should help. I wonder how that back test looks.
“Yours truly“: Hey, hey! I’ve given some thought to your comment on my slow journey to Hong Kong. Apologies for the delay in replying, but I figured I might
try to punt your way something worth reading. I put in bold what is immediately applicable to our economic data print before the market opens today (I would buy some NQ puts for end of July and hope they become blood sacrifice)
Summoning my inner former colleague and former-employer-style scenario analysis, I figured I would creatively define the version of the world where valuation multiples remain steady (relative to the forward curve on rates, in other words, the poor man’s macro guess) and some thesis on operational improvements, capex starting to be monetized leading to income/revenue/cash flow (keeping in mind REITs can have negative revenues) and balance sheet adjustments around the edges….
… I am looking at you offshore drillers,my favorite sector after anything that has the buzzword AI written all over it …. as my base case. I’ll assume that this
base case meets our return hurdle and make some… wait for it… downside and upside cases based on corporate performance to start seeing if the micro-economic return profile has appeal for our carefully defined investment mandate. These scenarios would be further split into “to the moon” / “this ain’t
going nowhere” and “oh, this is bad” scenarios if applicable to the underlying commodities/unit economics of the business. This is the first pass to determine if a specific “value” stock is worth looking at. It’s more intellectually satisfying to buy a good company that people are selling into the ground than to buy NVIDIA (although I would be less poor by now…)
A quick note here from the tactical front relating to correlations and geopolitics, we need to be careful and properly hedge. Intuitively, if the underlying commodity appreciates, then those who produce said commodity, all things being equal, will do better. Now the correlation breaks around some events. An example is Platinum Group Metal Miners and South Africa Events (more than half of platinum-ish metals come from there). When said geographies do not so great things, spot spikes (reduced supply) and equities in the geography drop (tax hikes, mining ban, revolts, and revolutions). Hence, we should think of holding some spot/futures on the underlying for these correlation breaks and monetize the deviation on the commodity if and when it happens.
Now to your point about the value trap, maybe I would dare to be pedantic and specify it to value multiple trap. There are two main components to model here; rates and liquidity/capital flows.
Currently, the macro is supportive to both bonds and equities in this goldilocks regime (rising tide floats all boats part of the cycle) where inflation continues
steadily to taper and economic growth is slowing but not yet getting to the point of contraction. The path for the FED due to (shhhhh its all politics based on made-up numbers) “the data, the incoming data, the evolving outlook and the balance of risks, and not in consideration of other factors, and that would include political factors” remains in the direction of some 100bps of cuts through the end of 2025 and possibly a cut before the election (me thinks). Historically an environment where rate cuts are priced into weakening growth and bonds have been beaten down is a bullish setup for both equities and bonds. Intuitively, why should this hold? For the past two-three years, we have been on a downward momentum of bonds with compressing volatility due to institutions not looking to buy longer duration risk (why buy 10yr @ 4.3%, when can buy 2yr @ 4.6? As rate cuts start materializing, we will see the curve bull-steepening and smart money moving to longer durations. This is a longer-term cyclical view on bonds and a return to equity-bond correlation, which have been muted as of late. As capital moves out the duration risk curve from the short end and rates rally, assuming the underlying economy grows although possibly at a slower rate, capital will continue allocating to equities to benefit from the pricing in of rate cuts on the back of soft economic data (I do think some “1/e*100″% (magic number I came up with) of the cuts have been priced in and I am only a buyer of equities on pullbacks). Let’s recall that equities have thus far since the rate hikes, rallied on the back of strong economic data and improved earnings and are slowly transitioning to meet ATH’s on the back of prayed-for rate cuts but remain driven by earnings. I expect equities to continue meeting their ascent on the back of multiples being kind to our portfolios but it will be a bumpy ride or equities through year-end. I do think it will be a smoother ride for long-duration bonds; I am a buyer of TLT, ZN, and UB if CPI disappoints today and we have some retracement of prior levels. I expect this earnings season to have more disappointments and fewer “beats” and show the slowing of the American economic machine but remain historically exceptional; this should start the pricing in of bull-steepners, and widening of credit spreads while equities rally taking pauses along the way.
A quick note on the coming headline CPI print: a bit of nowcasting might do us some good to understand what is likely to happen. Not all inflationary forces are abating, Containerized Freight index is up 38% through June, Crude, Baltic dry, and gasoline are inching up. The expectation is falling around 3.1% (-20bps over last month) but I think it will remain flat. Core should fall in-line with consensus at 3.4% YoY. This sets us up for a pullback of around 100bps in equities on very thin trading due to people preferring beach and Mojito over their trading desks (not-pro-tip but you can do both) and a good buying opportunity for your favorite stocks. Now the magic number could come in cooler than expected and my hedges become a blood sacrifice to the macro gods.
Now that we have broached on liquidity we might as well come down to the point of this value trap I have been avoiding all this time. Some industries are just not popular and avoided like the plague, much like yours truly in middle school….. This leads the whole sector to be cheap, but what is cheap sometimes is not a bargain and just stays cheap. Look at dirty non-renewable fossil fuels like coal, the whole sector looks like some Black Friday deal but some companies in the sector are set to outperform their peers from an operational perspective (Whitehaven for instance) in addition to having tailwinds for the survivors from a cash flow perspective from secular coal price appreciation from increased cheap energy demand from the “third world” (those selfish people who won’t drive Teslas and have solar panels on their rooftops!!!) coupled with reduced coal supply due to a dying industry that is strangled by the banks who won’t finance new mines. The future looks bright for the good operators in some dying industries (for the medium-term future at least) akin to whale oil used for lamps way back in the day (does not exist now, but the producers who lasted longer than others reaped the rewards of very expensive whale oil). The liquidity component of multiples will keep some stocks and some industries suppressed relative to the broader market just because big money won’t go near it. When investing in these value stocks, we need to be cognizant that the capital flow component of the investment might not come to the rescue and therefore we rely more on the business operations and the broader industry trend. One way to partly hedge the liquidity component is to compose long/short baskets of good and bad operators in an industry where the short on the bad operators benefit from liquidity evaporating and the longs benefit from good operations potentially providing a superior return profile to just being long the good operators.
I’ll publish the next part in a second publication