Deep Value Letter - Banner Ad / Email Capture

Saturday, January 22, 2011

Safe Cheap and Skeptical


I wrote a variation of this article on RealMoney recently but of course I am somewhat more constrained and correct in those pages than I am here. The upshot of it all is that I am done apologizing for my economic and market outlooks. I have often found myself apologetic for taking a stance that is contrary to folks that have Ivy League degrees, white shoe firm pedigrees and a shitload of initials behind their name. I have none of those. Far from having fancy degree I was actually a high school dropout. To be fair kick out is a far more accurate term. I was not a well behaved youth and had spent a fair amount of time behind bars lng before I was old enough to be in bars.

I do not apologize for that either. I eventually graduated at the age of 17 by going to night school while washing dishes, busing tables and cooking at a dive in downtown Baltimore. For a while there I cooked at the drug and alcohol rehab where my father was a counselor while polishing off my diploma. While it was not a perfect path, nor one I would recommend or allow my kids to follow, I have to say it was an education in and of itself. I know that at some point I should have gone back and gotten a degree but the truth is that there is just been too much life to live, too many adventures to have and far too mnay other interesting things to do than sit in a classroom.

I learned what I know through books. Of course I have read all the graham Books, Klarman’s book, Marty Whitman’s and every other significant piece of literature related to value oriented investing. I have read all the important technical books growth bools and just about everything I could get my hands on about markets over the years. In addition I found time to work in Adam Smith, Milton Freedman, Hayek, Keynes, Marx and Mises. I didn’t learn it all in a classroom but I think I have a pretty good handle on the subject.

I often find myself defending my current position. There is no doubt that forcing money into the market is good for stocks and fanfuckingtastic for Wall Street. With rates at zero there is no other place to put money. Of course that’s going to push stock prices higher. I do not think the market is particularly cheap as earnings achieved through cost cutting, inventory management and accounting measures are not growth. There is very little top line growth going on in the US right now. Let’s say the idiot, I mean analysts are right and we will indeed achieve Nirvana this year and hit $96 in earnings on the S&P 500. In real terms the growth rate of our economy is roughly zero. A zero growth rate according to everything I have ever learned deserves a multiple of 8.5. That gives us a fair value of about 816, a far cry from yesterday’s close of 1283. There will be some who tell me I am wrong about the zero growth rate and cite government stats and other horse crap about why we have this great recovery. To which I reply if we were growing we would be seeing JOBS created. We are not nor do we appear likely to do so. Repositioning is not growth.

I also take a little flack for my long term structural view of the economy and markets. While easing measures have bailed out bond traders and stock jockeys we have not done much to repair the country. In fact I think we have harmed it deeply. I fail to see how we grow enough to deal with the deficits we continue to pile up. These measures are not creating jobs; all the cash thrown in the markets have not healed the real estate markets. We have allowed those that created the problem to prosper at the expense of those who suffered. I am not talking about the idiots that borrowed too much money for too much house or used their house as an ATM. They are as much to blame as anyone. What about the poor ass that paid his bills, lived within his means and was unfortunate enough to buy the stocks as the best long term choice mantra and invested his kids college fund and his 401K accordingly. That poor bastard got hosed. Now he is going to be stuck with a higher tax bill to pay for this mess.

They told us that all kinds of bad things would happen if they did not bail out the banks.so what? Is my reply. Sometimes the piper has to get paid and this was one of them. Yes it would have been a mess and some of the big guys would have failed. Again, so what? I think banks like BB&T, M&T and even Wells that did not have the mess the giants had would have filled the void. There’s a good chance that JP Morgan would have made it through. is the world really a better place because we saved Goldman, B of A and Citi? I do not necessarily think so.

Here is where are now. State and municipal fianc├ęs are mess and probably going to get worse. Real estate, income and sale taxes are the lion’s share of most state revenues. With real estate down, a 20% real unemployment rate of 20% and justifiably scared consumer I question how quickly these recover. The federal budget deficit is out of control and the debt is rising at an alarming rate. The stock market is higher but the bulk of the volume is form algorithmic traders and there is very little long term investing going on right now. ETFs and indexes are distorting valuations and the retail investor has left in disgust. Our capital markets look like casinos without the benefit of showgirl and free cocktails. This is a party that has to end at some point and there will be a hangover.

The upshot of all this is that I am even more cautious than usual. The emperor not only has no clothes he has a tiny wee-wee. When this becomes apparent I think the market will price a lot lower. It might not be in 2011 as the free lunch provided by liquidity and forced asset allocation holds sway. But it is going to happen and I do not want to be the guy paying the bill when the party ends. You cannot borrow your way to prosperity. Smart phones cannot be the basis of an economy as you cannot text your way to prosperity either.

Two things have given me a greater deal of confidence in my views of the markets and economy. First as I mentioned in my Real Money article I am finding that an awful lot of smart people with degrees and letter have almost exactly the same viewpoint I do. I am not some lone voice in the desert preaching doom and gloom. I am actually in well-educated experienced company in my views. The other factor is that historical record of my ramblings. I have been cautious about the markets and limited my buying to only the cheapest names for several years now. There are warnings on the foolishness in real estate as far back as 2006. Throughout I have remained cautious and openly skeptical of government involvement in the markets. It has worked and I have to my surprise been right far more than I have been wrong about the outcomes.

I shall openly and proudly confess that my biggest missed call was 2009. I badly underestimated the markets ability to recover. The impact of the printing presses surpassed anything I could have imagined. I failed to see how powerful the Fed could be in influencing the direction of the stock market. I will also say that following the discipline of buying what was too cheap also worked far better than I could have ever imagined.

I am not always right. Nor am I always wrong. I am however done apologizing for being cautious. The first question I always ask is what can go wrong with this? Right now I see a lot of things that can wrong with our fiscal policies. Unlike 2008 and 2009 I do not see a lot of cheap assets that I should buy no matter what I think the economy is going to do. That sends up a huge red flag for me. I think we have fiscal and structural issues that could be problematic for us and I think stock prices are too high given what’s going on in the rest of the world outside the beltway and the rivers.

Right now I am content to drift along buying the occasional super cheap stock and waiting for things to adjust to my perceptions. I think they will. Then there will be sufficient cheap assets to get more heavily invested. I’ ll continue to track and buy thrift conversions as that is one area of the market that I think has extraordinary potential If you have a mutual thrift in your town go now and deposit a few bucks to get at the head of the IPO line. I do not feel the need to chase the market or attempt to out trade the black boxes and ETF traders that currently control the landscape.

I am at heart an optimist about this country. I always have been and always will be. I have no idea what the catalyst will be to correct the current fiscal missteps I see. At some point we will figure it out of that I am sure the 70s lead to Reaganomics, Mike Milken and a sustained 25 year burst of prosperity. It won’t be the same path to a brighter fiscal future but a path will open and the right person will hopefully emerge to take us there. I have a suspicion that this time the path is a combination of reduced assistance to Wall Street and infrastructure spending that creates real jobs and expands payrolls and the tax base but the jury is still out on that. I would like to think it was a return to hands off economics that lead us out of the wilderness but we may have passed the point where that would work. But if we are going to spend money let’s spend it on rebuilding the nations electric and water systems as well as transportation infrastructure in a way that creates job and leaves open a return to Austrian methodologies down the road.

When it comes to governments and markets I will never again apologize for being cautious, critical and suspicious. It has served me well for a long time now and probably will for years to come. Safe chaep and skeptical shall remain my mantra.

Friday, January 14, 2011


My country tis of thee, what the fuck have you done? I sit here day by day watching the news scroll across the screens and I often cannot believe what I see. Mr. Bernanke tells us he is not printing money but not to worry anyway because whatever you call it is working. His evidence of this is that the stock market is higher. Now I work around the edges of Wall Street and I love it when the market is higher. In spite of my cautious view of things I own quite a lot of stock and the market rising is very good for me. The merger activity created by the lack of real economic growth makes my inner arbitrageur want to sing sally sunshine songs. However when I look at the real world I see a problem. Unemployment is still bad and real estate is not getting better by any stretch. We had over 1 million foreclosures last year and more than 2 million folks got at least one foreclosure notice. Now the foreclosure process is bottlenecking in the courts and there is still a large shadow inventory of homes out there. Unemployment claims are consistently high and the terminally unemployed number is growing. When I talk to friends who own businesses I find that business is better but still a long way from great. All this means is they are no longer draining their bank account to stay afloat. It does not mean they are anywhere close to adding jobs.

On top of it the price of the stuff we use every day is going higher. All that lovely money we did not print but nonetheless put into circulation is driving the prices of the commodities higher. In a really jarring nte around Chez Melvin coffee is up over 60% and that’s just a hardship. If I still drank scotch the rise in grain prices would just be insulting. Crude oil is up 15% and gas is back over $3 a gallon. Cotton alone is up almost 100% in the last year and this is driving apparel costs higher. While all Americans may not own stocks we all do eat, use energy and with the exception of certain celebrities we like to go about fully dresses. The cost of all this is adding up at a time when many are still looking for jobs and trying to hang onto their house. The gap between those inside the beltway or between the rivers and the rest of the country is growing and that really is not good for the future. A large disparity between Main Street and Wall Street simply is not good for the country and may spark enough discontent that people put down their remote and take action.

Or not. Illinois just passed a whopping 70% tax increase without cutting any government expenses. Here in Maryland they are talking about raising the gas tax and adding a drink tax on alcoholic drinks. California is a just a hot mess and even peace and love space trooper Jerry Brown says that costs must be cut. The states are such a mess as sales and real estate tax revenues decline and across the board are suggesting cuts in service and higher taxes. Yet, nobody seems to give a shit. At both the state and federal level the mantra seems to be that those with more should pay more. Here’s a news flash dumbass, we already do. Someone told me yesterday that is was fair that I paid more since I made more than they did. Um NO! Fair is we both pay the same percentage. I ll still pay more but it will be fair. A-Rod hits better than most. Should we tie one arm behind his back to make it fair? Right now my total tax bills add to more than half what I make. How the fuck is that fair?

Enough of all this. It’s a 1970s style mess and I do not at this time see a Reagan rising to turn the tide. However at heart I am optimistic about the US and think we will muddle through and find our way out of the morass. It may just take a while longer than I like. In the meantime there is still stuff to do to make a few bucks. Cheap stocks are thin on the ground but there are some around and hopefully they will continue to keep me afloat until the world gets better.

Avatar Holdings (AVTR) is trading at half of a book value and as long as people prefer Sunshine over snow land value in Florida and Arizona will eventually recover. In the meantime management seems to be doing a great job of managing the balance sheet and adding properties at distressed values. The grocery business sucks with tight margins and gladiator like competition but Winn-Dixie’s (WINN) stock price more than reflects the state of the industry. At less than 60% of book and no debt they have to be on the takeover radar screen. I am in total agreement with Mike Milkens position on education. We have to focus on this area to remain great and this should provide favorable trends for LeapFrog (LF) eventually. Presidential Life (PLFE) and Kimball International (KBALB) are stupid cheap at less than half of book value. As a bonus they are profitable and are seeing insider buying.

The thrift conversion trade is going to be exciting. As mutual thrifts are forced to convert to stock ownership we will see some incredible bargain in solid smaller banks. I have already bought Fox Chase (FXCB) and Capital Financial (CFFND) and there will be more. It’s the closest thing to free money on Wall Street. I also still own Shore Bancshares (SHBI) here on the Eastern Shore and think I will be well rewarded for doing so over the next few years. The small bank trade could easily be a get rich investment over the next decade and I continue to track the sector for additional bargain issues.

With real estate so depressed I think you have to have some presence in that market. I like Commonwealth REIT at yields over 8%. They own high quality properties and you can buy them at half of tangible book value. I also continue to like the fractured mortgage back securities market. I like Invesco real estate since Wilbur Ross’s research team advises the REIT. At today’s price it yields 17.50%. You can also buy Chimera (CIM) yielding over 16%.Start small with these and add on sell offs.

I am staying short treasuries as well. In addition opt the commodity inflation I see the simple fact is that on the long end we are not a good enough credit risk to pay less than 5%. Our budget and balance sheet are a mess and getting worse. I own TLT puts and intend to for some time to come. I am also looking to buy puts on the various high yield ETFs. Junk spreads are stupid low and that market will implode sometime this year in my opinion. A small position in the puts could have a large pay off.

Okay enough business. Onto to things that really matter like baseball. The orioles have added some power on the corners and that has been desperately needed. Slowly but surely the lineup gets better. If mark Reynolds can strike out less than 200 times and take advantage of the short porches in the yard he could be a home run and RBI machine. Derek Lee is a steady presence at first and again the short fences could allow him to rebuild his power numbers. The youngsters on the pitching staff will hopefully get better. Kevin Gregg improves the bullpen one of our glaring weak spots. The club played a lot better under Buck Showalter late in the season they could be fun to watch next year.

It is January so I am an optimist. The realist in me looks at what the Red Sox added and my heart sinks. That is a very good baseball team right now. Speaking of the Red Sox I have been forced to deal with a dilemma regarding this team. I have long hated the Beantown Boys. I am not a fan of their trend following owner John Henry. He sucked enough money out of unsuspecting retail investors with fee laden commodity partnerships over the years that its impossible for me to cheer for his team (in addition to 49 years of other reason to hate the damn Red Sox). Now Seth Klarman has bought part of the team. Klarman is a man I admire and respect. He is one of the greatest value investors of this or any other generation. After some soul searching I came to the conclusion that I will always root for Seth in life and in the markets. In the American league East however we shall be enemies.

The Ravens so far are doing what the Ravens always do. They make it more interesting than they should but they win. If they play every game like the KC beat down last weekend they can get to the big one. However the Steelers are in the way this Saturday and that is a formidable obstacle. Any fan of old school football has to love a Ravens-Steelers game. They don’t track touchdowns as much as they do causalities when these teams meet. It should be a great game and with a little luck and blocking on the long haired freak we will hopefully win the game and move on. I find I have to root for the Jets this weekend as well so we can get a home playoff game and avenge 1969.

The world moves on and changes abound. If you felt the planet shift on its axis on September 10th 2010 the answer is simple. I got married. His time last year I had pretty much given up on the idea of finding love and any sort of marital bliss. Once I determined to move on in a flurry of books and scotch it found me. I knew by the second date that something special was happening and by the end of the third I knew Erin was the “One”. Describing the way I feel when we are together is impossible even for a wordy bastard like me. Suffice it to sat I am incredibly happy. A year ago I could not imagine not being by myself. Today I cannot imagine not having Erin at the center of my life.

This will of course mean less tales of alcohol fueled rampages on Second Avenue and Rush Street in this space. Darryl’s ditch is probably safe from future damage as well. Trust me dear reader this is a good thing. I am sure I will slip in one or two over the years but full throat stupidity will no longer be an every weekend addition to the story. Once the stiches came out and the ribs healed it was a lot of fun most of the time and some of the stories were hysterical. This is better. I am far happier (to say nothing of safer) on the couch with my wife with a glass of wine than I can remember being.

And so on we go. There is a lot wrong with the world but there is a lot right as well. If we have learned anything from history is that the forward march of man finds a way to work through problems and that the US has too many entrepreneurs, innovators and economic heroes to not overcome the current stupidity. In the meantime we have friends and loved one to keep us inspired and mentally healthy; we have laughter, music and book to keep us from drowning in insanity. There so many special moments that make up a life, rather they be quite nights with the one you love or nights of well-fed friends and family enjoying too much wine and each other’s company to ever take it all too seriously. After all not one of us gets out alive so we might as well enjoy the ride. Like quickly, love deeply and drink up my friends. The adventure as always continues.