Lessons

Today's lesson is one that burns. I am very fortunate (whether by skill, or perhaps and I readily admit, a few healthy doses of good luck) that in a terrible environment for investment markets I have managed to grind out positive returns in the last twelve months. I may regret saying that in the near future, as I take a firmly glass half full view on all things Eurozone and over leveraged Western consumers. I could very easily lose a lot of money - and quickly. 

Nonetheless I am pleased with how I have fared. And yet, I should have fared 2% better. I bit the bullet and sold out of RCU today at a substantial loss. RCU is the one stock in my portfolio where I deviated from the principles that govern every other position, and it has cost me badly. This reinforces exactly how important discipline is to the investment process. 

So, what can I take away from this to ensure I improve as an investor ?

No matter how cheap it looks  - even if it is 0.3x book....

1) Stick to higher quality businesses. It works!

2) Stay the hell away from highly leveraged balance sheets. Especially when depending on who you listen to, the global banking system is royally f*.....

Disappointing stuff, but a lesson learned. Onwards and upwards! 

I'm back!

Well it has been some time since my last post, as I have been held completely hostage to the wonders of the Spring Racing Carnival. I even managed a quick break from work to get down to Melbourne, and it was simply fantastic! A little bit more luck on the first Tuesday in November - I backed three horses at decent each way odds that went down by little more than an inch - and it would have been even better. 

Now invariably on a male trip away, sans wives, girlfriends and acquaintances, there are few opportunities for respite. After a long day in the sun at Flemington race course of making donations to the bookies and paying an arm and a leg for entry, food and drink, there really is only one option for the evening. That is to go to Crown Casino to win it all back. 

I have been to Crown once before with my wife in 2007. We stayed in Melbourne for the weekend just to get away from home. There had been a family tragedy and we just needed a break. Punching well above our weight, we booked in to Crown Towers for accommodation and the place was truly outstanding. However, neither of us being the casino type, we refrained from visiting the gaming floor on this occasion.

Fast forward to October 30, 2011. My first thought on walking in to the gaming floor was simply, wow. While others were thinking red or black, odds or evens, I couldn't help but start to wonder. How many people walk through here every day? How much do they spend? What are the margins? Is it always this busy? The floor was simply buzzing and I just smiled and thought, wow, I'd love to own some of this. 

What price would I pay? Hmmm, interesting question. That's for another post, but I can say that with the price hovering at around $8 a share I haven't bought any yet.

One day...

One day I would love to manage money professionally. 

When I do, I hope to be as smart as these guys...

http://www.brontecapital.com/Letters.html

Amazing returns. And I'd be lying if I didn't say I love reading John Hempton's blog.

 

2 years!

The passing of September marks two years since taking control of our family's humble retirement savings. Here is how it is going so far:

A few notes on the chart:

• Returns are pre-fees and costs (i.e. annual audit fees, our life insurance premiums).
• Despite putting this up, I'm actually not interested in returns over anything less than a 3 year period. This is capital invested for the very long term. Just thought it would be worth an interim update to see whether I should sack myself and give the cash back to the pros or whether my wife ought to leave me on account of losing all our money.
• When I can't find anything I am confident in I will hold plenty of cash, maybe up to 50% of the portfolio, but for the most part I plan to be very heavily (almost fully) invested in growth assets. I'd therefore expect some volatility and some periods of negative performance, but as I said I am looking at investments playing out over a much longer period of time than the last week, month or even year.

It's not exactly scintillating to see that I could have lobbed everything in to an at call cash account for two years and achieved the same raw returns. If I was a Markowitz man I'd be shattered... heavens, the excess risk I have taken for no excess return! What a shameful Sharpe ratio, information ratio bla bla bla. (My colleagues are well aware of my thoughts on MPT).

But overall I am actually pleased. It is very much a capital growth portfolio and to have held some cash in reserve while the market took an absolute beatdown has proved a wise move. I have put most of that cash to work now as markets have fallen and hopefully I will find some winners. I am actually very excited about the potential for crystallisation in latent value in two of my old favourites, Brickworks and Soul Patts, now that New Hope Corporation has thrown up the for sale sign. 

Despite huge falls, following the big rally last week I think Australian market valuations are merely OK. In aggregate the market is not a screaming bargain but is not exactly due for a 1987 crash either. I can't categorically state this won't happen - Europe is a mess but as steps are belatedly and reluctantly taken to avoid a systemic banking disaster I am much more sanguine about these risks than I was perhaps a month ago. 

There are of course individual pockets of value and some stocks which I think present excellent opportunities, but on a market wide basis I would not be backing up the truck. It promises to be an interesting 12 months as the E in the widely followed PE comes under plenty of scrutiny amidst significant private sector deleveraging, falling commodity prices and a stagnant property market. 

Wow...

That's it - put a fork in me, I'm done. 


A four, five, six percent rally on a rumour from none other than Steve Liesman, from undisclosed sources... involving leverage and a structure that has been described as a CDO "squared"... and to date with no hint of confirmation. This market is a joke.

Asset Allocation as at COB 26/9/2011

Pascometer Alert!

If you frequent the excellent blog at Macrobusiness, you will be aware of perhaps the most wonderful contrarian indicator known to man - The Pascometer. 

The Pascometer is a contrarian indicator that I first came across after chuckling at this article some time ago. Contributors and commenters alike at Macrobusiness have followed subsequent articles with greater scrutiny than I, however many of Pascoe's predictions have played out in the exact opposite manner to the way he anticipated. See here.

So you can imagine my alarm when I came across this article today!

SPARE me stories about a weak Australian dollar: it's not. Trading around US98¢, the Aussie is 3 per cent higher than it was a year ago and 63 per cent higher than when the GFC smashed it in 2008.

So we're off 11 per cent from our brief August high of US$1.10 - big deal. The Reserve Bank's trade-weighted index at 72.3 is exactly the same as September 23, 2010, and down just 6.8 per cent from its peak. With any sort of perspective on the Aussie's journey, trading a few cents either side of parity is strong. Doing it when most of the developed world is having conniptions about the possibility of the financial equivalent of a nuclear winter is absolutely amazing.

Headlines about a ''weak'' or crashing Aussie just demonstrate that it's human nature to have the attention span of a gnat. Or do gnats accuse each other of having the attention span of a human?

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Also, as usual, we tend to think it's all about us. Part of the Aussie's rally came from our economic credentials - our terms of trade, status as a China proxy, a strong, growing economy with relatively high interest rates. But a large part was just the flip side of the US dollar's weakness - a faltering economy, very low interest rates, massive and growing government debt, the government wanting a weaker currency, the Federal Reserve printing money, political paralysis and a bleak decade or so ahead.

None of those fundamentals has changed, so before thinking the Aussie has gone flaccid, consider that maybe the greenback has slipped a half tab of Viagra.

The headline alone made me want to charge off and buy as many out of the money puts on the AUDUSD as I could!


Here are my own personal views on the Aussie. If I'm wrong, so be it. In any case I think it would be a bit average to pass comment on Pascoe without putting my own opinion up for scrutiny.

• The so called fundamental strength of the Australian economy is not as great as it would seem. Make no mistake, we are in a relatively wonderful position, vis-a-vis many of our global counterparts. I am grateful to be an Australian, to have a job I enjoy that puts a nice roof over my head and nice food on the table. I am surprised however that unemployment has not ticked up more quickly to date, given the concentration of our workforce in the retail and construction sectors, both of which are struggling immensely.

• Australian consumers are short of confidence and are not spending as much as our "experts" have become accustomed to. Having borrowed uncontrollably in the good times, consumers have now chosen saving over spending, amongst considerable political & economic uncertainty. (I would also add fears over job security.) Such an environment (rising unemployment, restricted spending) may well to lead to a reduction in final demand across the economy and an easing of inflationary pressures. With an economy constrained by the burden of private debt, that by many measures, is comparable to - if not worse than - the United States at the height of the boom, I can see considerable cuts to interest rates as the RBA attempts to engineer some sort of rebound in economic activity.*

• I have no idea whether China will continue to grow at 9%, 15%, 3% or -5% per annum for the next 10 years. But I would suggest that three months of contraction in leading economic indicators whilst struggling to contain inflation may not be a great sign. Recent moves in commodities, especially copper, may signal rough seas ahead as global economic growth falls off a cliff. Heck the CEO of Rio Tinto himself even noted customers have been delaying orders of late. 

If I'm on the money, interest rates here are coming down and they are coming down a long way. As the yield differential relative to other currencies narrows, and China ends up being as much a part of the global economic malaise as I believe it is, then the AUD has every chance of going much much lower from here. I don't see it at 60 cents, but it wouldn't completely surprise me. I do not see it rallying strongly though as the USD's "viagra" wears off.

NJH

*As an aside whilst people see their super account being decimated and property falling (it's able to fall? Dear God!) in nominal terms, I am not sure how effective these measures would be. At least we are not at the zero bound as far as monetary policy is concerned. Yet. 

**Secondly, a random thought I just had. Wayne Swan the best treasurer in the world? Please. 

Soul Patts and Brickworks - Post Reporting, + Options

No real surprises here this morning. I am not even sure if the cross shareholdings were addressed at the company's respective analyst briefings - I guess I will have to read tomorrow's AFR to see if there was any discussion on this front.


One thing I did notice, was that Brickworks was increasingly transparent with respect to its extensive property holdings, and the potential values on offer upon successful rezoning of its land bank. It was almost as if the company was at pains to say "Here, look! Here is the hidden value on our balance sheet. Please take note of this. Please!!"


I don't have a lot of time at the moment, however on the weekend I do plan to put together some updated valuations of both companies and will post them on my blog.


In the meantime I am actually looking forward to tomorrow (now today). I have a very small ASX 200 put option position in play which looks like it is about to turn sharply in my favour. I am not going to tell you how small the position is, because it is embarrassing - suffice to say that the premium paid will not bankrupt me should the option expire worthless a month from now.


I went in to the trade feeling as though there was about a 90-95% chance of losing my money. Volatility was not particularly low at the time either, so downside protection was not cheap and further skewed the odds against me. With that in mind, surely you must be asking, what the hell are you smoking man? Why make the trade? Well, there are were in fact a few reasons I thought I was an outside chance of making some money.


Here is a brief summary of my thinking behind the position, rightly or wrongly. Time will tell. 


1. The Eurozone is a complete and unmitigated disaster. I could not see any short-term resolution to the problems in Greece that could potentially provide a boost to markets.


2. Global growth has been deteriorating for a few months now. I believed the recent market turmoil would cause further deterioration in the growth outlook and that economic data may continue to surprise to the downside. 


3. In the outside chance that the Bernank disappointed yesterday, I felt commodities would take an absolute beating. This looks to be the case, with sharp falls in commodities accelerated by weaker than expected data out of China (on which I am already bearish). As I write oil, copper, silver and gold are all getting obliterated. 


In summary, we have a dearth of political and economic leadership to take necessary steps to address the very real problems we face (however revolutionary those steps need be), a global banking system that is largely insolvent and under enormous stress with interbank spreads rising steadily day by day, and the commodities complex being trashed as people belatedly realise China too is in this mess up to their eyeballs. 


Now could someone please remind me what the two most prominent sectors in the ASX 200 happen to be? Hmm, do materials and financial ring a bell? They should - and the fact that the resources and financials alone make up roughly 60% of the index is precisely where I see the potential for a large payoff, given the issues markets are presently facing.

Soul Patts & Brickworks

Tomorrow both Washington H. Soul Pattinson (SOL) and Brickworks (BKW) will be reporting their annual results for the year ended 31 July 2011. Naturally as an investor in both of these entities (Brickworks is my second largest holding) I am looking forward to having a look at the accounts to see how things are progressing. What has got me a touch more excited is recent press speculation that the two companies may be looking to take some action with respect to the much maligned cross-shareholding structure that has been in place for many years. 


I must admit I don't expect any revelations tomorrow but I would not be completely shocked if there was. Let us not forget that Rob Millner, chairman of both companies and to date a staunch defender of the diversification benefits offered by the cross-holdings, is also a shareholder like myself. I can think of $300 million reasons why it is also in the interests of the Millner family to see some sharp upward movements in the respective stock prices.


Here's hoping!


EDIT at 7am: I wouldn't mind seeing Soul Patt's lob a bid for the half of Brickworks that it doesn't own. Maybe a merger could be the way to go?

Greece - finished?

Via Bloomberg, quite a mind-blowing chart. The Greek 1 year bond:

What does it mean? I'd be lying if I said I knew exactly, other than it is not looking pretty. Germany and the Netherlands have now threatened to block rescue payments to Greece until stipulated targets are met - a move seen by some as a threat to eject Greece from the Eurozone. 

Greece is now teetering on the precipice.

Welcome

"...as we know, there are known knowns; these are things we know we know. We also know that there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns - the ones we don't know we don't know."

So said former Secretary of Defence, Donald Rumsfeld. I thank Donald for providing the inspiration behind the title of this blog.