13F Fun

So, for fun, I wrote a script that grabs manager holdings and compares the portfolio since the last time a 13F was filed. This is available at places like dataroma.com but I wanted to be able to check out my own institutions that may not be superinvestors.

When I wanted to diff the 13F files, I used to download them to a spreadsheet and do it manually.  It was a pain because for companies like BRK who may have the same stock listed across subsidiaries, you had to aggregate the holdings. Many of you know what a pain that is.

Computer Stuff (uh, yes, it's a tangent)
Anyway, to make matters more interesting (OK, for most of you this part is irrelevant and not very interesting) I wrote this whole program on a Linux laptop (Ubuntu 14.04 at the time; I have since upgraded to Ubuntu 16.04) using the VIM editor (I used to use vi in a Unix environment a long time ago in my hedge fund days). Programmers know how much of a pain VI/VIM is until you get used to it. I had to refresh my memory but thought it was so cool to use vi again so I stuck it out and used it to write the whole program.  (Now I use mostly Geany on my Linux machine, Notepad++ on Windows machines, and Idle or Spyder (depending on project) for Python).

The program itself is written in PHP, and I used the XAMPP/Apache web server as my local host.  Anyway, something like this would have been much easier for me to write in Python, but I think I wanted some stuff on the web so wrote it directly in PHP.  I haven't worked with Flask/Django so wouldn't know how to put Python-generated content on a website (well, there are other ways; I do use Python to update google sheets and then use PHP to grab google sheet data etc. for some non-financial stuff I do).

All of this happened a few months ago, actually.

Linux/Open Source
...and here's another thing (another tangent off a tangent).  After turning my old, dead (or so I thought) Dell laptop (XPS M1710 that used to run Windows XP) into a Linux machine, I have really been loving the experience.

And what I noticed is that if you go to Barnes & Noble and look for computer-related magazines, you will see a bunch of them about Ubuntu, Linux and others.  I love those Linux magazines but they are expensive.  Why are they expensive?  Because they are all published in Britain!  Linux Voice, Linux Format etc... they are all published in the UK.  Even the website design/programming related magazines are all UK magazines.

If you have kids, the other cool thing these days (other than Pokemon Go) is the Raspberry Pi, which is basically just a cheap computer on a motherboard  (google it to see what it's about).  And that's a UK invention, so of course, all of the Raspberry Pi related magazines are published in the UK.

Maybe there is something about the publishing industry in the UK that make these magazines possible.  Or maybe there is too much commercialism in the U.S. for there to be support for anything open source (and therefore anything threatening Microsoft). I don't know. If it's open source, nobody is going to make money, and if nobody is going to make money, who is going to buy ad pages?  Maybe that's it.

But it makes me wonder.  As a geek into this sort of thing, it seems like the UK is a much more exciting place. Also, it seems like they are more committed to teaching coding in the schools.

This sort of makes me wonder where the next wave of great innovations will come from. But, OK, who am I kidding? I'm sure the U.S. will keep leading the way.

Anyway, that's straying too far from what this blog is supposed to be about.

Back to 13F's
Let's browse through some 13F's.  Most of this stuff has been seen and discussed already.  Many websites track 13F's closely and write about it, so I won't mention most of the big investors.

Having said that, let's look at BRK.


BERKSHIRE HATHAWAY INC

Name	dollar amt	%port	#shares	change	%chg
KRAFT HEINZ CO	28,812,169	22.21%	325,634,818
WELLS FARGO & CO NEW	22,704,405	17.50%	479,704,270
COCA COLA CO	18,132,000	13.98%	400,000,000
INTERNATIONAL BUSINESS MACHS	12,329,439	9.51%	81,232,303
AMERICAN EXPRESS CO	9,211,866	7.10%	151,610,700
PHILLIPS 66	6,250,563	4.82%	78,782,000	3,231,255	4%
US BANCORP DEL	3,430,598	2.64%	85,063,167
DAVITA HEALTHCARE PARTNERS I	2,981,889	2.30%	38,565,570
WAL MART STORES INC	2,937,332	2.26%	40,226,402	-15,009,461	-27%
MOODYS CORP	2,311,805	1.78%	24,669,778
CHARTER COMMUNICATIONS INC N	2,134,924	1.65%	9,337,491	9,337,491	new
DEERE & CO	1,779,577	1.37%	21,959,246	-1,321,748	-6%
GOLDMAN SACHS GROUP INC	1,628,365	1.26%	10,959,519
APPLE INC	1,455,768	1.12%	15,227,702	5,415,955	55%
GENERAL MTRS CO	1,415,000	1.09%	50,000,000
VERISIGN INC	1,119,894	0.86%	12,952,745	-32,255	-0%
LIBERTY MEDIA CORP DELAWARE	1,073,699	0.83%	37,499,996	7,499,996	25%
U S G CORP	1,051,494	0.81%	39,002,016
LIBERTY GLOBAL PLC	902,592	0.70%	30,712,739	6,903,848	29%
VERIZON COMMUNICATIONS INC	837,652	0.65%	15,000,928
BANK OF NEW YORK MELLON CORP	809,137	0.62%	20,827,212
VISA INC	759,438	0.59%	10,239,160
COSTCO WHSL CORP NEW	680,511	0.52%	4,333,363
M & T BK CORP	636,319	0.49%	5,382,040
AXALTA COATING SYS LTD	618,786	0.48%	23,324,000
SUNCOR ENERGY INC NEW	617,696	0.48%	22,275,381	-7,724,619	-26%
KINDER MORGAN INC DEL	496,708	0.38%	26,533,525
MASTERCARD INC	434,555	0.34%	4,934,756
TORCHMARK CORP	392,788	0.30%	6,353,727
RESTAURANT BRANDS INTL INC	351,030	0.27%	8,438,225
GENERAL ELECTRIC CO	333,233	0.26%	10,585,502
WABCO HLDGS INC	296,420	0.23%	3,237,094
TWENTY FIRST CENTY FOX INC	242,148	0.19%	8,951,869
SANOFI	163,461	0.13%	3,905,875
VERISK ANALYTICS INC	126,763	0.10%	1,563,434
MEDIA GEN INC NEW	59,672	0.05%	3,471,309
GRAHAM HLDGS CO	52,663	0.04%	107,575
JOHNSON & JOHNSON	39,677	0.03%	327,100
NOW INC	33,116	0.03%	1,825,569
PROCTER & GAMBLE CO	26,705	0.02%	315,400
MONDELEZ INTL INC	26,305	0.02%	578,000
UNITED PARCEL SERVICE INC	6,399	0.00%	59,400
LEE ENTERPRISES INC	170	0.00%	88,863
CHARTER COMMUNICATIONS INC D	0	0.00%	10,326,803	-10,326,803	-100%
Total Sum	129,704,731

(sorry, but my tables show adding and dumping Charter Communication, but that's due to change in the class of stock, I suppose, from the merger.  Name changes also show up like this in my tables so look at the whole table before assuming a position was dumped).

Buffett has really been accumulating PSX. It's been on my to-do list for a while, to make a post about it.  It is interesting because it is reasonably valued and doesn't seem to be impacted too much by crude oil prices.  They haven't been growing much, but their earnings have been pretty stable throughout a period when crude oil prices just tanked.  Their refining margins seem pretty stable too so it doesn't look like they are over-earning on excessive refinery margins either.  

You know that Buffett likes management as he has owned COP in the past. Maybe this is the good side.  

Buffett has been reticent, in recent years, about making comments about individual investments.  I remember he shied away from answering someone's question about why he bought DE, and didn't answer a question about PSX either.  He just said it's not a crude oil play. He used to talk up a lot of his holdings much more liberally.  I think the change came after IBM. He did explain why he liked IBM and it hasn't turned out too well. Maybe he didn't like the attention of talking up a name and having so many people focus on it as a big mistake (my view is that it's still too early to tell!). 

But we know that he likes managements that explain very clearly what they are going to do, and especially when they accomplish it. He is most interested in what management has in mind in terms of capital allocation; how much capex will be done, how much will be returned to shareholders in dividends and share repurchases.  And you will notice that PSX is very clear on those issues in their reports and presentations. 

Anyway, looking at the BRK 13-F, I was curious what it would look like if we exclude Buffett's big picks and looked only at Todd and Ted's excellent adventure. I just cut and pasted the above into a spreasheet and deleted what I thought were obvious Buffett picks.  Of course, that includes the big ones, and some other smaller ones.  This list may still include some Buffett stocks, but that's OK. 

Here's a look-see: 

Name	dollar amt	%port
DAVITA HEALTHCARE PARTNERS I	2,981,889	16.74%
CHARTER COMMUNICATIONS INC N	2,134,924	11.99%
APPLE INC	1,455,768	8.17%
GENERAL MTRS CO	1,415,000	7.95%
VERISIGN INC	1,119,894	6.29%
LIBERTY MEDIA CORP DELAWARE	1,073,699	6.03%
LIBERTY GLOBAL PLC	902,592	5.07%
VERIZON COMMUNICATIONS INC	837,652	4.70%
BANK OF NEW YORK MELLON CORP	809,137	4.54%
VISA INC	759,438	4.26%
AXALTA COATING SYS LTD	618,786	3.47%
SUNCOR ENERGY INC NEW	617,696	3.47%
KINDER MORGAN INC DEL	496,708	2.79%
MASTERCARD INC	434,555	2.44%
TORCHMARK CORP	392,788	2.21%
RESTAURANT BRANDS INTL INC	351,030	1.97%
GENERAL ELECTRIC CO	333,233	1.87%
WABCO HLDGS INC	296,420	1.66%
TWENTY FIRST CENTY FOX INC	242,148	1.36%
SANOFI	163,461	0.92%
VERISK ANALYTICS INC	126,763	0.71%
MEDIA GEN INC NEW	59,672	0.34%
GRAHAM HLDGS CO	52,663	0.30%
JOHNSON & JOHNSON	39,677	0.22%
NOW INC	33,116	0.19%
PROCTER & GAMBLE CO	26,705	0.15%
MONDELEZ INTL INC	26,305	0.15%
UNITED PARCEL SERVICE INC	6,399	0.04%
LEE ENTERPRISES INC	170	0.00%
CHARTER COMMUNICATIONS INC D	0	0.00%
Total Sum	17,808,288

Anyway, the concentration in DVA, CHTR and AAPL etc. is very interesting. I am still not a big fan of AAPL, by the way.  But this is a long term thing, not a short term thing.  I know AAPL is evolving from a hardware, gadget company to a services company, but I am still not convinced this market cap can be maintained.

Plus, I saw a video about AAPL recently and the thing that struck me was how old all the senior managers are.  Now, age discrimination is not cool at all, and I love how companies are hiring older people; we need to keep older folks working, and many do want to work.  I love that sort of thing. Not to mention Buffett/Munger.  

But when you have a company in a quickly evolving industry, especially in tech, my impression is that youth is pretty important.  The AAPL senior management seems older than the IBM senior management back in the 80's and 90's when they were sort of stuck.  Those aren't the kind of guys that are going to be the leaders in innovation. 

Anyway, that's just my impression.  I felt like, holy cow, no wonder why they make some mind-boggling and strange decisions; they are a generation apart from a lot of their users. I think this will be an issue at some point. 

But then again, what do I know. I am not a tech guy, really. 

Moving on... 

SQ Advisors

Let's see what Lou Simpson has been up to.  He obviously still likes his main holdings, but look!  There's a new name!  Allison Transmission Holdings (ALSN).  This is an old Carlyle name, and ValueAct has a position. Carlyle is completely out, I think. 

ALSN seems like a good post idea here too; I may do that after taking a closer look.  Revenues haven't grown much, but the story is in the free cash flows from increasing margins.  They are generating tons of cash and are repurchasing shares etc.  A formula that we like.  This leads to another digression.  

Name	dollar amt	%port	#shares	change	%chg
BROOKFIELD ASSET MGMT INC	395,284	16.73%	11,961,690	-979,557	-8%
BERKSHIRE HATHAWAY INC DEL	356,730	15.10%	2,432,332	-222,699	-8%
AMETEK INC NEW	344,723	14.59%	7,456,694	-484,585	-6%
SCHWAB CHARLES CORP NEW	292,606	12.39%	11,560,900	-719,054	-6%
WELLS FARGO & CO NEW	275,483	11.66%	5,820,464	-381,628	-6%
LIBERTY GLOBAL PLC	249,859	10.58%	8,685,850	-505,729	-6%
ALLISON TRANSMISSION HLDGS I	129,536	5.48%	4,588,604	4,588,604	new
WABCO HLDGS INC	128,135	5.42%	1,399,310	-102,928	-7%
CROWN HOLDINGS INC	74,230	3.14%	1,464,961	-1,496,522	-51%
US BANCORP DEL	62,431	2.64%	1,548,005	-413,603	-21%
VALEANT PHARMACEUTICALS INTL	48,868	2.07%	2,427,903	-163,496	-6%
BROOKFIELD BUSINESS PARTNERS	4,632	0.20%	243,059	243,059	new
Total Sum	2,362,517

Share Repurchases

There was an article the other day in the New York Times about how bad share repurchases are. I was scratching my head throughout the whole article because we sort of like share repurchases. This is a typical problem with the press.  Something is either good or bad. Corporations are good or bad. All banks are good or bad.  Moslems are good or bad. Cops are good or bad. 

Anyway, I don't want to spend much time getting too much into this, but I think most of us here agree that there are good share repurchases and bad ones.  If you buy shares under intrinsic value with excess cash flow, it's probably good.  If you overpay with debt-funded cash, then it might be bad.  Even still, it depends. 

The examples sited in the article were typical errors in thinking too.  Oftentimes, companies repurchase shares because there is no better alternative.  For example, companies that have very little growth potential will start to repurchase shares more. So you can mistake cause and effect. Someone may argue that they aren't growing because they are using their capital to repurchase shares. Managements will tell you that they are repurchasing shares because the growth opportunities are not that exciting. 

We can bash companies for repurchasing shares, but let's not forget that there was popular word in the old days called di-worsification.  I think that was a Peter Lynch word.  What about M&A? People keep reminding us that M&A's usually end badly. What about excess capacity? Building more factories with not much demand growth won't help anybody. As for retailers, do we really need more stores?

Share repurchases recycle capital back into the economy. It is not automatically good or bad. Look at Japan and their low returns on capital; largely because they don't want to return capital to shareholders. They would rather hoard the cash, make stupid acquisitions overseas, speculate, buy expensive real estate, diworsify into an industry they have no knowledge of, build unnecessary facilities for unnecessary employees etc...  

So maybe unbelievable to some, there are things far worse than share repurchases. 

Anyway, I am preaching to the choir here, so let's move on... 

Alleghany

This is a company many of us follow and like.  The equity portfolio manager, though, is relatively new and doesn't have much to do with Y's long term performance so there may not be much interest in picking apart this portfolio. 

But we are curious so we will take a look.  Who knows where the next great idea comes from? Anyway, it is kind of interesting to look at this as the characteristic of the portfolio seems to have changed from before. 

Notice GOOG at the top with an 11% position.  This is not what you would really imagine as a Y stock. But I like GOOG so it's fine with me. Not that I would second guess anyone. It is a relatively concentrated portfolio and I usually consider that a good thing. 

Name	dollar amt	%port	#shares	change	%chg
ALPHABET INC	288,446	11.06%	410,000
CVS HEALTH CORP	205,841	7.89%	2,150,000
MICROSOFT CORP	153,510	5.89%	3,000,000
BLACKROCK INC	136,984	5.25%	400,000	175,000	78%
ROPER INDS INC NEW	136,429	5.23%	800,000	-25,000	-3%
CSX CORP	130,400	5.00%	5,000,000
ALLERGAN PLC	115,517	4.43%	500,000	500,000	new
VISA INC	111,255	4.27%	1,500,000	-1,500,000	-50%
JPMORGAN CHASE & CO	108,383	4.16%	1,744,178
BARRICK GOLD CORP	106,750	4.09%	5,000,000	5,000,000	new
PPG INDS INC	104,149	3.99%	1,000,000	-525,000	-34%
WALT DISNEY CO	102,711	3.94%	1,050,000
DENTSPLY INTL INC NEW	99,264	3.81%	1,600,000
EXXON MOBIL CORP	93,740	3.60%	1,000,000	700,000	233%
VERIZON COMMUNICATIONS INC	92,417	3.54%	1,655,000	-375,000	-18%
DISNEY WALT CO	83,148	3.19%	850,000
EOG RES INC	56,995	2.19%	683,406	-316,594	-32%
AIR PRODS & CHEMS INC	54,685	2.10%	385,000
COMCAST CORP NEW	51,817	1.99%	795,000	795,000	new
OLD REP INTL CORP	48,225	1.85%	2,500,000	-331,467	-12%
ARAMARK	46,628	1.79%	1,395,000
BERKSHIRE HATHAWAY INC DEL	41,986	1.61%	290,000
HOME DEPOT INC	32,561	1.25%	255,000
DEVON ENERGY CORP NEW	31,890	1.22%	880,000
NEWELL BRANDS INC	30,985	1.19%	637,877	637,877	new
KIMBERLY CLARK CORP	27,493	1.05%	200,000
PEPSICO INC	27,016	1.04%	255,000
HESS CORP	24,338	0.93%	405,000
L BRANDS INC	23,163	0.89%	345,000
OCCIDENTAL PETE CORP DEL	21,535	0.83%	285,000
POLARIS INDS INC	14,309	0.55%	175,000	175,000	new
ARES CAP CORP	2,674	0.10%	188,326	4,660	3%
ARES COML REAL ESTATE CORP	1,538	0.06%	125,115
CONSOLIDATED TOMOKA LD CO	578	0.02%	12,166	12,166	new
ARES DYNAMIC CR ALLOCATION F	131	0.01%	9,550	224	2%
SABRE CORP	0	0.00%	1,890,000	-1,890,000	-100%
SMUCKER J M CO	0	0.00%	205,000	-205,000	-100%
PERRIGO CO PLC	0	0.00%	750,000	-750,000	-100%
JARDEN CORP	0	0.00%	740,000	-740,000	-100%
CHURCH & DWIGHT INC	0	0.00%	365,000	-365,000	-100%
ISHARES TR	0	0.00%	181,000	-181,000	-100%
Total Sum	2,607,491

OK, this post is getting a little long so I will break it up. More to follow... 

Scary Chart Part III: Missing the Trees for the Forest

OK, so this is a continuation of the scary chart series (not really intended to be a series, and not really intending to be so actively posting!).

Whenever I see these big charts showing how the markets are overvalued and whatnot, I usually just go back to looking under the hood on what's really going on.  Sometimes the P/E charts look crazy (like it did in 2000 and now), stock market to GDP is off the charts etc.

But at the end of the day, most of us here are not S&P 500 index futures traders; we are investors.  And we at least pretend to be owners in businesses and not shufflers of pieces of paper. In that sense, all of these macro forecasting charts should be totally irrelevant.  OK, so maybe we should be aware of some of this stuff. But as far as what to do about it, unless you have strong odds of something happening, it shouldn't really drive any action on the part of business owners.

Odds
Speaking of odds, odds are often misused (or unused) in finance. I can't claim to not misuse them either. But here's what I mean. So often you hear people say the market is overvalued so they are going to short the market.

One thing that struck me is that every time Joel Greenblatt is on TV, he tends to tell us what percentile of valuation we are in and what the year-forward expected return for the market from that valuation level is. Now, that has problems too as you can argue that all of that data is based on a bull market period when interest rates were going down. But as flawed as it is, it is still much better, I think, than just shorting the market because it is overvalued and therefore thinking it must go down.  If the market is overvalued, then the expected return going forward is going to be low, but not necessarily negative (over time).

Plus, for those calling a turn in interest rates, look at the long term chart of interest rates that go back 100 years or more, and you can see that these major turns don't happen very often.  So basically, the odds of calling the turn in any given year is not very high.

Anway, what you never hear from the "I'm short cuz the market is expensive" is something like that; from these levels, the probability of a crash or bear market within the next year is xx%".

What you do hear is that when markets are this expensive, things don't end well.  And they are often right. Things often don't end well. But then again, it all depends on what your definition of "end" is.

It was a certainty that things wouldn't end well in the late 1990's and 2000. And many geared up for it. Of those folks who actually caught the crash back then or got out in time, how many got back in? What is their total return through all the cycles since then?

For reference, BRK grew BPS 9.4%/year from 2000 through 2015. BRK stock price rose 7.1%/year since then. If you were smart enough to own MKL, they grew BPS +12%/year and the stock price rose +11%/year in that time period. The S&P 500 index total return was 5%/year.

The same was a certainty back in the late 1980's; it was a certainty that things wouldn't end well.  The above figures would be even more dramatic than the 2000-2015 figures. This is not to say that we will have high returns like that going forward!

Back to the Trees
OK, so getting back to the issue.  As I said, one thing I do when I see scary charts is to go back and look at my holdings to make sure none of them are bubbled up. To see what's in store for the market overall, I will look at some major components as a sanity check to see how bubbled up the market is.

One of the first places I look is Berkshire Hathaway's (BRK) holdings. Buffett is the greatest stockpicker ever with a live portfolio we get to see in real time. If the market is bubbled up, there might be risk built into BRK too, which we may want to be aware of.

I like to look at current P/E because ttm P/E often has a lot of noise, write-offs etc. Of course we can't ignore those 'one-offs' as they often are not, but I like to look at companies based on a normalized earnings basis, and for that, current P/E often reflects a little bit more of a normalized picture (as analysts estimates often exclude charges).

Forward P/E is for the year 2017, so may be too far ahead for some.  Anyway, we are more than half way through 2016, so the numbers should be decent estimates.

Here is the BRK portfolio; I only include companies listed in the annual report. CHTR and KHC are not here as there are no earnings estimates available. I added AAPL. The list includes non-Buffett names, but since it's in the annual report top-holdings list, might as well leave them in.

	CurrPE	FwdPE
AAPL	13.10	12.15
AXP	11.88	11.79
KO	22.91	21.77
DVA	18.38	16.51
DE	20.15	21.72
GS	11.44	9.54
IBM	12.01	11.49
MCO	22.54	20.12
PSX	23.98	13.95
PG	22.41	20.71
SNY	12.96	13.17
USB	13.08	12.47
USG	15.83	12.48
WMT	17.34	16.75
WFC	11.91	11.43
average	16.66	15.07
median	15.83	13.17

So, looking at this, I think to myself, "where is the bubble?".  OK, the FANG stocks and many others are really expensive, but who cares, really, if you don't own them.  Right?  OK, if those guys collapse and cause a correction or bear market, many stocks will go down.  But from a valuation perspective, I don't see a big problem here.

Someone said the market will crash 50%.  OK.  Maybe it will.  But take a look at the BRK stock list and then cut their valuations in half. Do they look like sustainable valuations down 50%? I don't know. I don't think so.

Let's take a look at something more representative. The S&P 500 index is too unwieldy to look at individual names, so let's just look at the Dow. It has a high historical correlation with the S&P 500 index so it can tell us something about the market.

Here is the same table as the above with the Dow 30 stocks:

	CurrPE	FwdPE
AAPL	13.11	12.15
AXP	11.91	11.82
BA	21.17	13.85
CAT	23.65	23.38
CSCO	13.28	12.68
CVX	81.87	21.55
DD	21.54	18.62
DIS	16.83	16.00
GE	20.86	18.19
GS	11.52	9.60
HD	21.72	19.14
IBM	12.10	11.59
INTC	13.85	12.68
JNJ	18.50	17.41
JPM	11.57	10.49
KO	22.91	21.77
MCD	21.47	19.44
MMM	22.05	20.48
MRK	17.01	16.61
MSFT	20.06	18.00
NKE	23.64	20.55
PFE	14.29	13.26
PG	22.41	20.70
TRV	12.47	12.04
UNH	18.03	15.74
UTX	16.59	15.82
V	28.62	24.05
VZ	13.83	13.35
WMT	17.32	16.73
XOM	36.75	19.84
average	20.70	16.59
median	18.27	16.67

The Dow is trading at around 20.7x P/E, and 16.6x 2017 estimates. Well, actually, that's the simple average P/E of the Dow stocks.  Yes, on the high side historically. But again, I don't really see anything bubblish.  The high P/Es of XOM, CAT, CVX are due to depressed earnings, not speculative frenzy.  Some of the other high P/E names seem to be trading at where they have traded in the past.  Maybe some a little higher, but for the most part, they seem consistent with what I would expect them to be trading at in 'normal' times.  Nothing really screaming out at me that it has to crash. 

Conclusion

I'm really pushing it here with these posts; I know I'm setting everything up for a big crash. But it doesn't matter. That's not my game; I can't tell you if the market will crash or not. Don't look at this stuff and assume that it won't.

Bears will argue that the above P/E ratios are not valid as margins are bloated.  Well, if you go through the lists carefully, I don't agree that anyone is actually earning bloated margins.  Also, they will argue that revenues are largely funded by central bank money and government debt and therefore unsustainable (welfare checks spent at Walmart etc.)

I don't really know what to say to that and how to adjust for it, as it is really hard to predict where the demand will come from in the future. 

Anyway, I'm just looking at some things here and there to see what I find.

Scary Chart Part II

OK, so there was some feedback from my post about the scary chart.  A bunch of other scary charts were offered up along with a presentation by the great Stanley Druckenmiller.  I am a huge fan of Druckenmiller; he is no doubt one of the greatest traders of all time.

When I started out in the business, the must reads were, of course, Reminiscences of a Stock Operator and these books:


 

I started out in the trading side of the business more than the investment side, as you can tell from these books.  I wouldn't consider any of these books essential reading for the typical value investor, but they are great books to learn how great traders think and make money.  These are true classics from the all-time greats, even though I may not be a big fan of some of folks in them.  

Druckenmiller is featured in the second book, The New Market Wizards.  It's a great interview. You can't argue with what he says and you can't argue with his results!

Speaking of great interview collections, the above two may not be required reading for value investors, but there are two that I think are must reads.  There have been a lot of books like these in the recent past too, and many of them are great, but these two are true classics.  Most of you have read these, but I think some of the younger generation may not have read these; they used to be available at book stores, but I haven't seen these recently. 

The first book includes investors such as Warren Buffett, Paul Cabot, Philip Fisher, Benjamin Graham, T. Rowe Price, John Templeton, Larry Tisch, Robert Wilson etc. 

The second book includes investors such as Jim Rogers, Michael Steinhardt, Philip Carret, George Soros, John Neff, Ralph Wanger, Peter Lynch etc. 

I've been meaning to reread all of these for a while.  I should do it now that I've mentioned them.  I feel like the Book-lyn Investor today. 

Back to Scary Charts

Anyway, OK, let's look at some of this scary stuff.  Druckenmiller's presentation is really good and it is true that returns going forward are probably not going to be as great as it was in the past.  The wind at our back of constantly decreasing interest rates and increasing valuations along with a strong economy largely driven by increasing leverage in the system may become headwinds going forward.  We can't expect much of a valuation boost from lower interest rates, nor a stronger-than-deserved economy based on increasing leverage (bring forward demand). 

Here are the charts that tell this story: 

These charts are truly scary.

But here's the thing. The exact same argument has been made since at least 1990.  Check out the same charts as above only cut off in the early 1990's.  The same exact argument was made at the time.  In fact, during the 1990 bear market, it was claimed that we can't recover for these reasons.

Look at the chart below.  It was claimed that the stock market bull was driven largely by the bond bull market; lower rates => higher valuation.  Interest rates were back to levels last seen in the 1960's.  That was a pretty dramatic chart back then, and the bond bull market of the 1980's really looked complete no matter how you looked at it.

It was also claimed that the entire bull market and strong economy was fake and was driven largely by increasing debt.

The chart below looked really scary in the late 1980's and early 1990's.  It was commonly believed that the bull market in interest rates was near an end and that the debt levels in this country was at a limit.  The economy and entire system had only one way to go: down.

And yet, the S&P 500 has increased seven-fold since 1992 (total return), for a 9%+ annualized return.  If you said back then that the market would return 9%/year over the next 23 years, they would've thought you were nuts.  Like, how can that happen?



When the market collapsed in 2000 and 2008, similar things were said.  Returns haven't been so great since 2000 to be sure.

Now go back and look at the first debt chart. I have no idea how and why the debt was able to rise so much since 1990 with little effect.  I have some theories and ideas, but maybe that's for another post.  Can we keep going up like that?  Probably not.

With interest rates, I have no idea where they would go.  If I was sure rates would go back to 6-8% within a year, then I have some great trade ideas.  But I have no idea, really. I really believe that it is just as likely that 10-year rates will be 0.5% as it will be 3.0%.

Conclusion
This is not to say there won't be nasty bear markets ahead.  There will be.  The folks calling for a big bear market / crash are much smarter and richer than I am.  So I would not ignore those views.

On the other hand, we have to remember that these calls have been made in the past and sometimes the most obvious, inevitable conclusions don't pan out as expected. This is not to say that these scenarios will never pan out. I'm just pointing out that it's really hard for even the smartest people to figure out when it will happen.

Japan, for example, looked arithmetically at an end-point, ready for a complete implosion.  And yet, that day hasn't come yet.  We might as well call the JGB market the widow-maker.  Seriously.

This is not to say that just because something hasn't happened yet, that it won't ever happen.  Overweight, heavy-drinking smokers can tell you they are fine, and that they've been fine for many years.  Still, I would not bet on their long term health.  But I wouldn't really bet on their imminent death either.

This is a sort of post I don't like to make, especially with the market making new highs, VIX and put/call ratios at lows etc. It makes me feel like the market will crash right after I hit the "publish" button.

Anyway, again, as with my other posts on the topic, I am not predicting a continuing bull market or an imminent bear market or anything like that.

And there is a lot I don't understand.  Where and when will the rubber band of debt snap, especially in Japan?  Debt levels can't keep going up forever.  If rates do go up, a lot of this debt won't be serviceable.  The math there is terrible.  But when does this become an issue?  I have no idea.


SuperInvestor Portfolios
By the way, for new people, I have a couple of pages on the blog where I post screen/sorts of superinvestor portfolios.  The portfolio holdings themselves come from Dataroma.  Every week, I sort the holdings by year-to-date returns and also do a valuation sort.

The year-to-date returns have been working fine, but the fundamentals sort kind of broke because Yahoo Finance changed their website; the old program stopped working.

I am actually working on that as I type; the small portfolio has been updated successfully, but the large portfolio script keeps crashing.  It takes a lot of time now since the Yahoo Finance statistics page has Javascript enabled content, meaning I can't just grab data off the website easily like before.  Now I have to use a browser and let the Javascript run to put the content on the web page before grabbing the data, and this takes time.

So go take a look.  The script skips names when any errors occur, so there may be some valid names not included in the screens; I saw that the script kicked out PEP for some reason.  I have to do this so the program doesn't crash in the middle of a long run etc...

SuperInvestor Winners and Losers
SuperInvestor Stock Rankings

Scary Chart!

Another post!  Don't assume this is going to be the normal frequency going forward.  I think my previous pace of 1-4 posts a month is the best you should expect.  Anyway, I came across (again) a scary looking chart, and I hear people screaming to sell everything now, so I thought I'd revisit the issue of the whole market again.  This may be new to people who are new here so there is that too.

Anyway, check out this chart below.   Here is the full article:
Advisor Perspectives article on NYSE margin debt

Digression
Oh, and by the way, I noticed that Sequoia initiated a position in Chipotle (CMG).  I still really like CMG, but I also agree that it is not a cheap stock at all.  I did buy some due to this 'crisis', though, even though it didn't get cheap by the usual measures.

Anyway, I think they did get a raw deal last year.  CMG tried to explain that every time the CDC came out with announcements, that they were not new cases of food poisoning, but just announcements of old ones that already happened. They all happened early on, clustered during a certain period. But the annoucements of each case dragged out a little at a time, so what it looked like was that CMG had a food poisoning case and then they announce measures to fix it, and then another announcement comes that happened BEFORE the fixes were put in place. But the public thinks it happened AFTER measures were taken to prevent it.

So things looked really out of control.  People were like, holy cow, they can't stop it!

But that was never the case. I think they will be back even if it takes a little more time (due to the above, unfortunate thing).

Oh, and by the way, the chorizo burrito is amazing!

Back to Topic
To be fair, the author doesn't claim that this is an indicator of any sort.  But I've seen/heard others warn about this as an indicator of a coming crash.



Yeah, it's scary alright.  In the full article, there are various variations of this chart.  But I was curious why they didn't put up the one that seems to me the most important.  When I saw this chart, my first reaction was, well, gee, it's a coincident indicator.  Of course margin debt goes up when the market goes up and vice versa.  That's sort of natural and you would expect that.  The question is, as far as I'm concerned, how much is margin debt expanding relative to market cap?   Back in the late 1990's, one of the tells was that this margin debt expanded suddenly and exponentially.

How is it looking these days?  You can google "margin debt as percent of market cap" to get long term charts of this.   I recreated it with data from NYSE, but the data didn't go back too far. Maybe there is fuller data somewhere, but for now, I just found stuff back to 2004.

Check it out:

NYSE Margin Debt as % of NYSE Market Cap

Anyway, margin debt went above 2.00% of market cap back in 2013. I think that was the marker of a bubble in the past, and the market is up 50% since then.  Of course, this doesn't mean that a bubble doesn't exist.  It is possible that the speculative frenzy goes further and lasts longer than people imagine and then implodes.

But if you compare it to the 2000 spike, it isn't similar at all.  It doesn't feel like a speculative, blow-off spike in margin debt.  Back in 2000, margin debt blew up from 1.3% or so to 2.6%, basically doubling.  After the bubble popped, it came all the way back down to pre-bubble levels of around 1.3% (I'm eyeballing this on a long term chart so may be a little off).

Recently, it crept up from 1.8% at the crisis low up to close to 2.6% in January of this year.  It's been slow and gradual.  Debt is debt, though, so maybe this is not a mitigating factor.

Not to be too bullish, but there are many reasons why margin debt is higher these days than in the past.  Note how margin debt didn't go down that much even during the financial crisis.  That was when a lot of speculative excess was blown out.  There seems to be a lot of discussion about this here and there, but one major reason of an uptrending margin debt is that margin rates are a lot lower now than in the past due to competitors like Interactive Brokers who offer rates less than 1%.  Typically, margin rates are more in the 6-8% range regardless how low interest rates get.

In this environment, you can imagine a lot of carry trades going on; investors buying high yield stocks, MLP's (OK, maybe not so much now), REITs on margin.

Of course, that is not so comforting either.  When carry trades go too far (when too many people try to cross the same bridge at the same time), it can blow up.

But it's not the same as the late 1990's when people just bought stock splits and dot-coms on margin (I remember almost everyone seemed to have stock split announcements sent to their beepers at the time so they can enter buy orders on those names).

So even if it may not necessarily be good news, I think some of this margin debt simply reflects the divergence in dividend yields and interest rates; and for the first time in history it seems like individual investors can play the carry game with competitive cost of carry.


Other Scary Charts
The other scary thing these days that people keep talking about are valuation levels.  We are at historically high levels.   CAPE ratio is very high etc.

And the bears say, the bulls use interest rates as an excuse for the high valuation. They say that when interest rates finally start to go up, the stock market will take a hit.  This is true.

But let's take a look at some charts to see if there is any validity to the bulls (or, let's say, not-so-bearish arguments).

First of all, there are bears that argue that the Fed model (comparing stock market earnings yield to the 10-year bond yield) is flawed, and that it only worked for a short period of time in the past. This is also true and I sort of validated that in a previous post that I will go back to in a second.

But having said that, we still can't separate stock market valuation from interest rates. To use the time-honored tradition of hiding behind a higher authority to make a case, here is Warren Buffett himself tying the valuation of the stock market to interest rates, and long before the so-called Fed model showed any real correlation.  Read it here:

   Buffett on Market Valuation

When interest rates are low, asset prices are high for obvious reasons.  This is simple economics and I can't really convince anyone who doesn't agree with that.

The argument, I suppose, is that interest rates are at unsustainably low levels due to the central bank money-printing around the world (and therefore stock market valuations are unsustainably high).

There is some truth to that too. I won't argue with that.

So, since we looked at and talked about some popular 'scary' charts going around, let's look at some other charts that I like to look at that doesn't get passed around all that much, I suppose, due to the lack of dramatic effect; they are not scary!

Bond Yield versus Earnings Yield
First of all, if you are new here or you don't remember, skim this past post.  I scatter-plotted bond yields versus earnings yield going back to 1871.

Here is the post:  Scatter Plot

The data goes back decades so I didn't update it.  Adding 2015 to it won't make a big difference either way.

As you can see, there is a relationship between bond yields and earnings yield.  The longer the history, the less the correlation.  But that may be due to many things. Accounting rules, interest rate regulations etc.  Not to mention how stocks are valued in general; remember, in the old days stocks were considered speculative and it was unthinkable to buy a stock that yielded less than government bond yields.  But this was not true for most of the second half of the last century.

In any case, I too believe that interest rates are probably at unsustainably low levels, even though I still lean more towards "lower for longer", following the Japan model (but better).

So let's assume that interest rates will go UP, and then let's see how overvalued the market would be in that case.

My simple analysis is that long term interest rates should be around where nominal GDP growth is. See the above scatter-plot post for why I think so.

Let's say we get to what the Fed wants; 2% real growth and 2% real inflation.  That would give us a 10-year rate of 4.0%.

Here is a cut-and-paste from the scatter post:

When interest rates were between 4% and 6% since 1955, the stock market traded at an average P/E of 20.4x.  If you put standard deviation bands around the cluster, the range would be 16.6x - 26.6x for one standard deviation and 14x - 37.9x for two standard deviations.
If you expand the range to 4-7% or 4-8%, then the average P/E comes down to 14x, so in that case the market would look overvalued.  But I think a lot of the vertical dot cluster in the 7-8% range is from the 1970's.  Of course, we can't assume that won't happen again.
Just for fun, let's see these figures from 1980-2014.  Some will argue that this is no good since the market has been overvalued for most of the past three decades.  But again, let's just see for fun. 

                   Interest rate range            average P/E                   

                            4 - 6%                            23.3x                
                            4 - 7%                            22.7x
                            4 - 8%                            21.6x

If you do it by constant range (instead of expanding it) you get: 

                   Interest rate range           average P/E

                   4 - 6%                             23.3x
                   6 - 8%                             19.6x 

Using data since 1980, even if rates went up to the range of 6-8%, the market would be fairly valued at 19.6x P/E.

Yes, we can argue back and forth all day about whether we should use the data from 1871 to now, since 1955, since 1970 or since 1980.

I tend to favor excluding data from before 1950 for the usual reasons.  I know not everyone will agree with this, but that's OK.  I am not trying to predict the market or convince anyone of anything.  I am just looking at the facts and going, hmmm.... that's very interesting...

The point of the above is that even if interest rates go up A LOT,   (10-year rates are now 1.5%, so even if rates more than double), the market is not overvalued.

Regression Lines
I don't remember why I didn't tabulate the regression lines in the scatter post, but here it is.  The 1980-2007 line has a really nice fit with an R-squared of  0.77.  And yes, critics will argue that is overfitted as I am excluding periods that are inconvenient.

But it's not unreasonable to say that the 1970's was an aberration and the crisis too was one (period after 2007).  The regression fit nicely for 27 years, so that's not insignificant.

In any case, yes, it's kind of 'convenient' and maybe overstates the case to some extent. But even if you look at the regression for the periods 1955-2015 and 1970-2015,  they show that at an interest rate of 4.0% (more than double current level!), the market would be fairly valued at 19-21x P/E.

If rates continue to go down, I would NOT chase the market up and use lower interest rates to get fair value of the stock market. So I tend not to agree with people who say that the market is really undervalued with interest rates where they are.  The market is only really cheap if you think interest rates will stay at 1.5% for a really long time.

Conclusion
So there it is.  Some other charts that are not so dramatic and scary. Interest rates can go up a LOT and not really impact the fair value of the market.  This is not to say that there won't be short term blips.  If rates go up, stocks will probably go down.  But the point is that they don't necessarily have to move down a lot to correct valuation levels unless interest rates go up a lot more than 4-5%.

And, this is not to say that there won't be bear markets. Markets will go up and down regardless of all of this stuff, so this is not a prediction.  It's just a point of reference to see if there is any rubber band being stretched in any way that has to snap back violently.

(A short term chart like the above showed a serious deviation right before Black Monday).

If abnormally low interest rates are the reason you think the stock market is overvalued, then shorting bonds seems to be a much better idea than shorting stocks.

Added comment:  By the way, the bears keep saying that the bulls think this time is different.  Hmmm... The above charts sort of show that, no, at least in my case, I am claiming that this time is not different at all, and the market is trading right around where you would expect it to be trading at, even if rates get up to 4-6%.  Indeed, this time is not different.

Anyway, get yourself a Chiptopia card, try the chorizo burrito and enjoy these charts!

Record Valuation Spreads!

It's been a while, I know.  I was browsing around the net as usual and came across something that was at the back of my mind for a while now and it was graphically illustrated convincingly so I thought it would be a great excuse to break radio silence here.  Which, by the way, is not intentional.  I never made a decision to scale back posting or anything like that. I will try to get more active again because I do often have a lot to say about a lot of things.

Anyway, as usual, a digression (or two), even though I haven't even mentioned the main topic.

Brexit

It's a little late to be talking about this, but this is what I was thinking throughout this 'panic'.  Of course, like everyone else, I was terrified when the vote came.  I never really put much thought to it either way, but when I saw the markets going nuts, I was terrified.  

But then I thought about it for a second. OK, so the Brits want out.  Fine.  Capex and business might slow down for a while as there is uncertainty that wasn't there before; can we build a plant in Britain or not?  Do we have to move to continental Europe?  Will banks have to move or not?

Two things came to mind when thinking about this.  First of all, if you look at all the major tops, markets rarely make a top on some specific news like this.  This just felt like fiscal cliff and other mini-panics we've seen in the recent past. 

I couldn't imagine, that 20 years from now, that we would be sitting here and looking at a long term S&P 500 chart and go, "see here? That's the high of 2016.  Things were OK until Brexit and that was it.  It was all over...". 

No matter how hard I tried to imagine that, I couldn't. 

Second of all, yes there is short term uncertainty, just like the fiscal cliff, end of QE, 9/11 or whatever.  But if you look out over five or ten years, how much economic impact is Brexit going to have?  People are still going to eat, travel, buy cars and whatnot. Sure, things may be time-shifted due to uncertainty. Maybe someone holds off on expanding capacity in England until things are more clear.  Maybe things will shift geographically.  Maybe Nissan closes a factory in England and opens one in Germany instead.

Over time, things will be made and consumed.  In five years, I don't know if you'd be able to tell by looking at most company income statements and balance sheets what happened. 

And if that is the case, who cares?  The market will understandably go down as people take risk off due to short-term uncertainty, but that doesn't have anything to do with intrinsic value of great businesses five years out.

Also, as is often the case with these things, the situation is dynamic.  If you analyze the situation statically, then Brexit can be disastrous in many ways.  But it is a dynamic situation. We have to remember that the Europeans need the Brits too.  They can't just say, OK, fine.  Leave.  And no trade.  So people will have to work to minimize the damage.  Companies are not static, linear organizations.  They change and adapt to the situation (well, at least the good ones will). 

And not to mention the tendency in some situations for an over-reaction; for example, central banks/governments may, out of fear, overcompensate for the potential negative economic pressure.  And who knows, that might actually end up being bullish. 

So, after thinking about all of that, I chose to ignore Brexit, even though people I respect were saying that this is serious and is a big deal that will cause a huge crisis.  You know, it's still early so it might.  Who knows.  But this is not the sort of thing I think I have an edge in predicting. 

Alternative/Market Neutral Funds

Here's the other thing I've been thinking about again recently.  As you know, it's been a peeve of mine for years; mutual funds that try to tactically time the markets and make money in 'all' markets.  I guess there are some that can do it well over time, but most don't. 

I guess what is surprising to me is that some fund managers allocate short market positions as if it were an asset class.  For example, you have funds that think the market is overvalued so they are short the market. OK, for macro hedge funds that makes sense as they are active traders and manage their risk.  If they are wrong, they get out and try again later. 

But when you apply this sort of thing with an asset allocation mindset, then you end up short for years and have terrible performance. 

OK, that's fine.  But here's the part I don't get.  If stocks are overvalued, say, at 20x P/E, I can see how some may reduce their exposure, go to cash or bonds or whatever. 

But if you go short, just because expected returns are low, then your expected return on that short position is still negative, even though it's a small negative.  If you think expected returns for stocks is a low 2-4%/year going out, why on earth would you short the S&P 500 for an expected loss of 2-4%/year? 

That makes no sense to me.

Anyway, it's just another thing that has been baffling me recently.   Again, this doesn't apply to the macro hedge funds as they are active traders.  They don't go short and just sit on it for years (well, some actually do that but still manage their risk well enough to make money). 

Valuation Spreads

OK, so to get to the original topic of what this post is about.  I really enjoy the research by Pzena Investment Management.  I keep referring to them but I don't own any funds they manage, nor do I own the stock. And I don't know anyone that works there either, just to be clear as it might seem like I'm promoting them.  

Anyway, check these charts out.  They are sort of mind-blowing.  And for value investors, very exciting to see. 

Make sure to read the whole report here:  Pzena 2Q commentary 

The charts below are the valuation of the bottom quintile stocks compared to the average (or equal-weighted composite valuation).  The higher the figure, the cheaper the cheapest stocks are compared to the average.  Figure 5 shows the same but compares the cheapest stocks to the most expensive. 

You will see that the spread is at historically high levels.  That's kind of amazing.  This is very, very interesting considering the big boom now in 'passive' strategies.  Does this look like an environment where you would want to invest passively? 

OK, so up to here you might say, so what?  That's great for long/short equity funds. But what about long-only value guys?  Well, Pzena has already thought of that, and here is how the bottom quintile (cheap) has performed three and five years after the spread widens.

.

Alpha may not be too encouraging if you are a big bear.  10% alpha could still be a 20% loss if the market is down 30%. 

How to Play It? 

Of course, the obvious way to play it is to stick with cheap stocks.  That is always a great idea, but it seems like it's a really, really great idea now. 

But, there is another interesting idea here.  Most of you have probably already thought of this. 

You know that one of my favorite authors and fund managers has a company running mutual funds.  Yes, Joel Greenblatt. I'm so predictable. 

And yes, I know, the Gotham Funds have not been doing so great performance-wise.  But if you see the above charts, it's easy to see why:  expensive stocks have been getting more expensive and cheap stocks are getting cheaper. 

Now, I am not a big fan of mean-reversion when looking at the market.  I do believe in mean-reversion to a point.  But that has lead people astray for decades.  For example, people waiting for mean-reversion of P/E ratios in the stock market have been waiting for 20, 30 years. Dividend yields too, for even longer. People waiting for interest rates to mean-revert have been waiting for decades too. 

But some things do mean-revert much more reliably. I would say volatility is one of those things. Volatility can't and won't stay above 20-30% for any length of time. 

Another, I think, are the above valuation spreads.

If you think those charts will keep going up like that, then invest in momentum funds and chase the hottest funds and you'll be fine (if those charts keep going up exponentially like that). 

But if you think things will mean-revert, then piling into value stocks seems like a great idea. 

If you want to be market neutral and 'safe', then the Gotham long/short funds are probably perfect; it may be the best time, ever, to invest in the Gotham long/shorts. 

Gotham's long/short funds mechanically (with human overlay, I hope) short the dearest and buy the cheapest stocks.  True, they are not using P/B ratios, so investing in a Gotham long/short fund would not be the same as trading those charts above.  But I would imagine they would be correlated.

Gotham Funds

So, returns so far at Gotham haven't been so great.  Not so bad either, but not so exciting. The charts above sort of indicate why that was so, so far... 

...but things may be starting to look better...

Forgot to post this more updated table when I initially posted this.  Year-to-date looking much more interesting.  These returns can really take off on any big mean-reversion of valuation spreads...

So, if you think the above charts will keep going up, and more and more money will keep going into passive strategies, then ignore all of this, maybe. 

But, if you think that the above chart rubber bands will snap the other way, eventually, and that active managers will start to outperform passive strategies etc., then maybe think about investing in some good value managers, long/short equity funds etc

Here is their webiste:  Gotham website. 

I think today, this is one of the most contrarian bets you can make! 

Oh, and I don't know anyone at Gotham either...