Geoff Gannon July 21, 2008

Blogger Roundtable: July 2008

Note: My continuing weekly commentary on Benjamin Graham’s Security Analysis is being bumped for this roundtable; the commentary will appear here tomorrow morning. Sorry for the inconvenience.

This is a new format for Gannon On Investing – a pseudo-roundtable, where the same questions were posed to different bloggers simultaneously (via email). In this first post, we have answers from the authors of four of my favorite blogs: Fat Pitch Financials (GEORGE)Cheap Stocks (JON)Bill Rempel (BILL), and Controlled Greed (JOHN).


How have you fared so far in ’08?

George: It’s been a rough year for my portfolios so far. My Fat Pitch Financials Portfolio, which tracks my longer term value investment picks, is down 15.9% year to date (as of July 11th). My Special Situations Real Money Portfolio is down 6.7% year to date.

Jon: It’s been very challenging, especially the past month. Even some of the illiquid names I hold have started to come under pressure.

Bill: YTD as of 7/18 close, -1.67%.

John: My portfolio is down 12% through June 30th of this year.

What’s been your greatest success this year?

Bill: I’m not viewing the individual trade results as being composed of individual successes or failures. I view the process as one of methodology applied consistently, with individual trade results being somewhat randomly distributed over time, around an average result for that system. That holds true for relative value traders, GARP traders, cigar-butt traders, special situation traders, and other types of system traders. Sticking to a chosen system is the “success.” Currently I trade one of the four systems I track; in time, with a larger account, I’ll probably trade two simultaneously.

George: In my Fat Pitch Financials Portfolio, my position in Western Union (WU) seems to be holding up the best so far.

My greatest success this year in my Special Situations Real Money Portfolio was my investment in JACLYN INC (JLN) that I bought for $7.65 on April 4, 2008 and I was cashed out (since this company went private) for $10.21 per share on May 22nd.

John: ArmorGroup International, which traded in London, got taken over by a UK company called G4S for a gain this year of 147%. You’ll remember I talked about ArmorGroup in the “20 Questions” interview we did previously. I originally bought the company in September 2006. My gain from start to finish was 61.3%, or more than 36% on an annualized basis.

Jon: The launch of the Cheap Stocks 21 Net/Net Index, the first index that tracks a basket of companies trading below net current asset value has had some very interesting results. Since inception (2/12/08), it’s up more than 9%, while the closest benchmark, The Russell Microcap Index is down 10%. Pico Holdings has also made a very nice recovery

What’s been your greatest failure this year?

John: General Motors (GM), down 51.8% through June 30.

George: I recently made a big mistake not selling a stock immediately when its tender offer terms were modified and lowered. That stock, Sunstone Hotel (SHO) has plummeted since. I consider this my greatest failure since it was do to poor judgment. I believe this behavior is called anchoring.

Jon: Premier Exhibitions (PRXI), and 4 Kids Entertainment (KDE) have been big disappointments. I still hold both, and will likely continue to buy Premier.


On the U.S. stock market, are you a bull, a bear, or a chicken?

Bill: On the U.S. market, my Timing system for the SPY has been 25% stocks, 25% bonds, and 50% cash since pretty much the beginning of the year. Looking outside the system, at indicators not included in it, I still think that the general level set by the January (and now the July) lows will be a multi-year bottom.

Jon: Believe it or not, I am still a bull. I believe oil, not housing, not the financial crisis is the single biggest risk factor in the market

George: I’m starting to get bullish on the U.S. stock market. For the past few months, I’ve been a chicken, lol. The market has been pretty scary this year. The bursting of the housing bubble, depreciating dollar and increasing oil prices is a tough combination.

John: Oh, I’m bullish longer term. Shorter term, things are lousy and could even get worse. But I don’t invest for the short term

Are stocks cheap, expensive, or fairly valued?

Bill: How you look at “stocks” depends on how you aggregate the index, how you weight the components, etc. If the question is, “how is the S&P; 500 valued?”, I dunno. I haven’t done the math on it, and don’t really care. Certainly some individual stocks are fairly valued, some are cheap, and some are dear, by methods that I would consider using.

John: I don’t look from a top-down perspective. But bottom-up, there are lots of cheap stocks. If a buyer is willing to wait and suffer lower prices between now and when things recover down the road, he or she could see significant gains.

George: Stocks are starting to look cheap.

Jon: Cheap, at least where I am looking–the smallest of the small

Where is the market headed? What should investors do?

George: I don’t know where the market is headed, but with the failure of IndyMac last week and the turmoil that is coming Monday due to auctions for Fannie Mae and Freddie Mac bonds, I doubt the we will see any significant market gains next week.

Now is the time to find cash. Look under those couch cushions, shake the piggy bank, and save as much as you can. Plow that cash into value opportunities.

Jon: Investors should stay on course, and use some of their dry powder to pick up some bargains. I believe that we are at or near the point of there being blood in the street,

John: For a value guy with a long-term view, I think you buy inexpensive stocks if you’re willing to hold for several years, suffer any price declines, and not worry about the market.

Bill: I think individual traders should find a system (or systems) that work(s) over the long haul, and apply it (them) relentlessly. Even if they use the system as a screen for discretionary trades, provided the system itself is robust, they’ll do OK over time. Don’t worry about the day-to-day market moves, because in the long run, they’re irrelevant.


Why are oil prices where they are?

John: We’re hitting an area outside my circle of competence. I suspect it’s a combination of greater demand, refinery capacity not having kept pace over the past couple of decades or longer, and a “terror” premium added to oil prices. My hunch is that all the crying we hear about speculators is bull.

Jon: The declining dollar, hot spots in the Middle East, and speculation. We are in a vicious cycle, and each of these factors feeds the other. I believe Iran has no intention of attacking Israel, but is rather trying to disrupt our economy, with success, I might add.

George: Demand for oil continues to grow worldwide. Production may have peaked. The risk of supply disruptions is perceived to be high. Most importantly, buyers continue to be willing to pay the current high prices.

If you are interested in learning more about why the price of oil is established, I recommend studying Hotelling’s rule.

Bill: Oil prices are where they are (or were where they were) because of speculation. That’s the answer for all prices, SPECULATION. All market participants speculate, even those that are end-users or producers of commodities, even those not using leverage, even those buying “value” stocks with the intention of holding them for years.

Where are oil prices headed?

George: I think in the short term oil prices may continue to climb a bit higher to $150 per barrel. However, society is starting to make changes to confront higher oil prices. People are buying more efficient vehicles and driving less. Companies are investing more in energy efficiency and alternative fuel sources. I believe that next year we will see lower prices than we have today. Of course, this is really all just speculation, but it is what I think may be the most likely outcome.

Jon: Ultimately lower, perhaps the $60-$80 range. That presumes a stronger dollar, decreasing tensions in the hotspots, and that offshore drilling, and reduced consumer demand all become a reality. A tall order, I know.

Bill: The sarcastic answer is “they will fluctuate.” I think we saw a blow-off top in oil prices just now. Long-term, I think the cycle of gasoline prices is topped as well, and GM’s boneheaded too little, too late moves probably marked the top as well as any capitulation ever could.

John: My guess is lower this fall. I think there’s been a “bubble” effect with prices lately. But if America and/or Israel attack Iran, or another event happens in the Middle East, who knows?

What do oil prices mean to investors? Should they care? And what should they do today?

Bill: What should traders do about oil? The same thing they should do about the market, find and apply a methodology and stop “reacting.”

John: I believe investors like me should invest in undervalued companies. Spread your bets and let the chips fall where they may. Basing investments on oil prices strikes me as too much “top-down” investing. Of course, if gas suddenly shot up it could have a bad impact on a whole host of industries. But we’d adapt over time. I have relatives in England. They tell me they’re paying right around the equivalent of US$10 a gallon (a lot of that is taxes). They don’t like it, but life is going on over there.

George: As an investor, it is hard to completely dismiss oil prices. I think most investors should consider the macro impact of oil prices and also how it impacts their individual holdings.

As for what investors should do today, I think they should think about what value opportunities may exist in excellent companies that may have been overly discounted due to current oil prices.

Jon: Oil is the single biggest factor weighing on the markets, they should care, but need to be able to weather the storm. It is very difficult to do so psychologically, though


How bad is the economy?

Jon: Housing is bottoming, there are some positive signs there, unemployment is benign ( but may worsen), the credit crisis was improving, but Fannie and Freddie situation is of concern. I believe it’s not as bad as the pundits suggest. What frightens me most is one big shock to the system, i.e. oil supply shock, terrorist attack, etc, that really shuts things down, and frightens consumers worse than they already are. That aside, its not as bad as some think.

Bill: The economy is never as bad or good as you think it is. Certainly the rate of “real GDP” (which ISN’T “the economy”) change isn’t going to be as low as the consensus projection (read: it ain’t gonna be negative).

John: We’re definitely in the midst of an economic downturn. Whether it meets the textbook definition of a recession I’ll leave to others to decide, but things aren’t great, that’s for sure.

George: All I know is that the health of the economy is not good. Thing could end up a lot worse next week if the IndyMac takeover and the handling of Fannie Mae and Freddie Mac crisis is not handled properly.

How bad will it get?

Bill: I doubt we’ll see an overall “recession” (as called by the NBER) this year.

Jon: Fundamentals will improve, but elections are scary. I fear an Obama Presidency from an economic standpoint. His policies, if enacted will damage the free markets, and flow of capital. He makes George McGovern look like Ronald Reagan.

George: I hope not much worse, but if more major financial institutions fail that could get real ugly (see my previous answer). Inflation is also one of my biggest concerns right now.

John: I have no idea. When I read a smart guy like Francis Chou telling his investors that even the CEOs of these big financial firms have no idea if the bad stuff is on their own balance sheets, I pay attention. Then I recently read Ted Forstman, another smart fellow, saying in The Wall Street Journal the credit crisis is bad and that we’re only in the second inning of this mess. So it could get much worse. I’m hoping the second half of this year will tell us a lot, so that prospects for 2009 will look brighter. But what do I know? We might be muddling along another year or more after that.

Where does today’s economic environment fit in a historical context?

George: To some degree today’s economic environment is fairly unique. However, there appears to be some similarities to the 70s fuel crises era.

Bill: In historical context, this current “downturn” is milquetoast.

John: If it stays like it is, it certainly won’t rank among the worst downturns in American history, broadly speaking. In 1973-1974 and 1980-1982 things were worse with unemployment much higher. But if housing prices keep going down, and then the crisis moves on to credit cards, auto loans, etc., as some forecast — it could be a doozy.

Jon: Reminiscent in some ways, of the early 70’s, although not as bad

What does the macro economy mean to investors? Should they care? What should they do today?

Jon: They should care, but not to the point that it forces them to make a mistake. There are values out there. If they have dry powder, they should deploy some of it at current levels. They should be concerned about inflation, and hedge it (exposure to TIPS, Metals, perhaps REITS, even HY bonds). They should be well diversified across and within asset classes

George: Investors should try to have some understanding of the current macro environment. However, the focus should still be at the specific company level when analyzing various investment opportunities.

John: John Templeton died recently. Think of all the stuff that happened from the time John Templeton started the Templeton Growth Fund in 1954, to when he gave up daily management in 1987. Cold wars, hot wars, assassinations, scandals, Bull markets and Bear markets, you name it. Sure, the macro economy is important and I care about it. But the investor in me doesn’t let macro stuff get in the way. It’s mostly just noise.

Bill: Unless their system is based on macro projections, individual traders shouldn’t care. I think it’s unwise to base trading decisions on macro data, because it involves overlaying another set of assumptions and calculations, which gives just one more source for error. Certainly “value” based traders should IGNORE the macro data, or if they pay attention, run CONTRARY to the macro data, because the premise of “value” is that the market OVER-reacts to data. Follow the methodology.


Do you see any opportunities in financials? Housing? Real Estate?

George: I think it is still to early to invest in financials. It is hard to say any investment in this sector provides a margin of safety as the financial crisis continues to spread.

Jon: Definitely in real estate. I’d look at depressed companies that own land, and are not highly leveraged. Financials are still too scary for my blood.

Bill: I don’t usually look at individual stocks by sectors or industry group. I’m sure there are some fine opportunities in those areas, but for individual stocks I focus on the characteristics of the stock regardless of industry. When I look at Rotational next week, I’ll give an update on where I think the groups are headed, but I try to look at that in detail only once every four weeks – the picture really doesn’t change that quickly.

John: Non-bank financials, yes. I like some of the property and casualty insurance companies and the reinsurance companies. I own Tokio Marine Holdings ADRs (TKOMY) and Fairfax Financial Holdings (FFH), though I’ve sold enough Fairfax when it doubled in price to get my original capital back. So it’s a free ride for me. And there are some others I don’t own now, but may at some point — such as Munich Re and Montpelier Re (MRH) — that are attractive.

I’d stay away from the banks for now, though I’m sure you saw that Barron’s ran a Bullish cover story on them. I imagine we’ll see bargains at some point, like investors did during the savings and loan crisis in the early 1990s, but I don’t know if you can trust the balance sheets right now.

What’s the best general decision investors can make? Where should investors be looking today?

John: I believe the best general decision an investor can make is to stick it out and stand up to the headwinds we’re facing. I don’t invest by sector or country. I just try to find undervalued stocks. I’m based in the US and most of my stocks are based here. But there are lots of cheap stocks in Japan — though you really have to be careful about whether or not the managements are shareholder-friendly. We’re in a global economic downturn, so there are probably inexpensive stocks to be found most places.

Bill: Traders should execute their chosen methodology. If they don’t have one yet, they should find one.

George: The best general decision an investor can make today is to maintain a margin of safety. Investors should look broadly for opportunities but also acknowledge the limits of their circle of competence.

Jon: Small cap value for the long haul—I know that will surprise you. Look for depressed companies (from a price standpoint) with cash and little debt.

What stock do you like most today?

Jon: CBRL Group (CBRL) — does not fit the above definition to a T (does have leverage), but is extremely cheap, nice dividend yield (3.6%) and owns a lot of its real estate.

Bill: Choosing ONE for RIGHT NOW is a random process. It’s much more telling to see how the cumulative results of many different choices play out over years at a time.

John: I don’t like one most of all, but I’ll say King Pharmaceuticals (KG). I bought King in June at $9.98 and it’s been trading over $10 or $11 lately. King traded for more than $21 a share last year. The stock got hammered, primarily because it lost patent protection for its largest drug (a heart drug called Altace) in 2007.

King’s strategy is to acquire older branded drugs no longer being promoted by their originators. King then uses its salesforce to increase sales of these drugs through effective marketing. Look for the company to use its significant financial resources to seek new product opportunities.

At the current stock price, investors assume the worst-case scenario for King: that it will lose patent protections for its major profit makers while achieving no replacement revenues. I don’t believe that will happen and have placed my bet. But there are no guarantees.

George: I am still very happy with my investment in Sotheby’s (BID). This company has an impressive economic moat and is trading at a price lower than it deserves given its current performance.

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