Headed off to Omaha for our annual visit with The Oracle today. The “Other Loeb” and I will be flying solo as Hunt already spent his quality time with Warren at the grand opening of Nebraska Furniture Mart Texas. I’m sure we will hear all about it on Saturday. Looking forward to catching up with some old friends. Please drop us a line if you are in the neighborhood this week.
The bulls are quick to cite a dozen or so reasons why the ratio of Market Capitalization to GDP is not an effective valuation indicator – the economy has evolved over time; an increasing share of earnings are sourced from abroad; the components of the S&P have changed dramatically over the years; blah, blah, blah.
At the end of the day, the unfortunate truth is that the folks who take issue with this particular valuation yardstick are the same folks who benefit from telling investors to expect continued double-digit returns from stocks. Don’t ask a barber if you need a haircut.
We are all too quick to trust the experts. We are all influenced by incentives, so much so that if you hope for something enough, you can start to believe it. But sticking your head in the sand won’t change the fact that the chart below, compliments of Hussman Funds, is one of the best valuation indicators in terms of predictive ability.
Posted in Valuation.
– April 7, 2015
“I have not found among my possessions anything which I hold more dear than, or value so much as, the knowledge of the actions of great men, acquired by long experience in contemporary affairs, and a continued study of antiquity.”
“A wise man ought always to follow the paths beaten by great men. Let him act like the clever archers who, designing to hit the mark which yet appears too far distant, and knowing the limits to which the strength of their bow attains, take aim much higher than the mark, not to reach by their strength or arrow to so great a height, but to be able with the aid of so high an aim to hit the mark they wish to reach.”
– Niccolò Machiavelli
Posted in Quotes.
– March 29, 2015
A few more thoughts on recognizing where we are in the cycle, illustrated by SG:
The US has now “enjoyed” its longest bull market since WWII. Over this period, the S&P gained over 200%, making it the third-strongest six-year run since 1900. The two others, 1929 and 1999, did not end well.
This has also been one of the longest periods not to have seen a 10% correction, according to SG. The current 800 trading days was only exceeded in 1999 and 2007 ?. Those periods did not end well either.
Posted in Portfolio Strategy.
– March 20, 2015
“There are many well-documented examples of complacency in today’s global capital markets, but one particular alarm, too often overlooked by investors, has been persistently ringing louder. Investor’s insatiable appetite for higher yielding, lower quality debt is the driving force behind the current buyout boom in which private-equity firms gobble up corporate stock and finance the acquisition with heaps of new debt. But as the domestic equity markets cheer the surge in leveraged buyouts, and the size of announced deals gets larger with each passing Merger Monday, the fundamental wisdom behind each deal gets smaller.”
There is nothing permanent except change. While the above quote may be just as relevant today, it was first written in the inaugural edition of the Broyhill Letter published in January 2007. The rest, as they say, is history.
Bull markets have a way of sucking everyone in at the top, as Seth Klarman noted in his most recent annual letter. “Today, stocks and bonds are both in favor; tomorrow, and without notice, this could change. Markets, like hemlines, will rise and fall. The current flavor of the month can turn sour. It is that “turning sour” that can happen rather quickly . . . the problem is, when the market reaches the top of a mountain is when certain groups of investors jump in.”
As illustrated in the chart below, those “certain groups” do not exclude companies themselves. My good friend Nik Modi at RBC recently highlighted the number of billion dollar deals in a research note updating his views on the 2015 Consumer Outlook. Nik believes: “There is an opportunity for investors to take advantage of the stepped up special situations activity we began to see in the back half of 2014.” His best ideas include ENR, where the company’s personal care businesses could be taken out, post-spin. Apparently there are at least a few other guys who still see value in batteries. Note: Buffett’s Berkshire Hathaway buys P&G’s Duracell.
Nik does excellent work on the consumer space and has been spot on with ENR over the years (for what it’s worth, he also had one of the best three-point shots on our high school team despite giving up at least a good foot in height). Unfortunately for us, he was also spot on with his bearish AVP call which we ignored (better luck next time Nik).
That being said, we do tend to agree with his bullish outlook on the opportunity set in special situations. Energizer’s Form 10 is on my desk and on our on-deck list. We are still finding pockets of value in this market although those pockets are getting shallower and often filled with a ball of lint rather than the pleasant surprise that comes with finding a crumpled up dollar bill. In other words, investment decisions cannot be made in isolation. As a result, investments must be made in the context of economic, credit and sentiment cycles all of which are getting long in the tooth as we discussed here. Surging buyouts are yet another cyclical indicator.
History has shown time and again that buybacks and acquisitions are extremely procyclical. Both can be excellent, if not imperfect, measures of corporate sentiment. With activist war chests larger than ever and the velocity of 13D filings only outdone by Hillary’s personal emails, it’s easy to justify paying a high price for a security on the basis that someone else will come along and offer a still higher price for the same investment. But this doesn’t change the name of the game. Selling to a “greater fool” is still a fools game. The chart below shows the last three times “billion dollar fools” showed up in force. We saw this in 2000. We saw this in 2007. And we are seeing it today. Don’t be a fool.
M&A Deals Over $1 Billion
– March 16, 2015
Promising investments can come from anywhere. There are no patents on investment ideas. The only common factor in our search for fifty cent dollars is the thrill of the hunt. Often, some of our best ideas are sourced from within the existing portfolio. This may entail less of a “hunt” but can be even more fun and just as rewarding.
Last year, we committed significant resources to understanding the opportunity set in European real estate and presented our investment thesis on Kennedy Wilson (KW) at ValueX in June. In that presentation, Around the World with Kennedy Wilson, we illustrated the positive fundamentals underpinning the Irish real estate market, where KW enjoyed first mover advantage.
In that presentation, we explained that cap rates had come down, but relative to local interest rates, spreads remained very attractive. Commercial property prices and rents fell 60-70% during the crisis. Both had rebounded, but Irish property was coming off of a very low base.
The real opportunity was on the supply side or lack thereof. There had not been a single crane on the Dublin skyline since 2006-2007. Construction completely dried up. At the same time, demand for prime real estate was soaring. Prior periods of declining rents in Dublin (illustrated above) had historically been followed by mulitple up years. After such a dramatic fall, we suggested last year’s move was just the beginning.
We’ve since made a second investment in the space, focused specifically on Dublin real estate. A crashing euro masked strengthening fundamentals for a while, but it appears the market has begun to get it right.
To put this story in perspective, CBRE’s 2015 Irish Commerical Real Estate Outlook demonstrates the recovery taking place as does Jones Lang LaSalle’s Dublin Office Market Review and Outlook 2015. A few highlights:
Availability of prime office space across Dublin declined by over 40% last year. The Grade A vacancy rate in Dublin 2/4 at year-end was 2.0% – you read that right – 2.0% vacancy. Overall vacancies are forecast to drop further.
No new space was delivered last year. And no new space is expected to be delivered this year. Consequently, supply shortages have pushed prime rents in the region more than 28% higher during the year.
Prime headline rents in the district have increased to about €45 per square foot. CBRE expects rents to rise by as much as 22% in 2015 to €55 per square foot.
Prime Office yields stood at 5.0% at year-end. CBRE is looking for another 50 bps of yield compression in 2015. Probably not a stretch if rates continue on their current path. The Irish 10 Year currently yields less than 1%. Treasuries over 2% not looking so bad all of a sudden.
With 95% of Green’s portfolio based in Dublin and an investment yield north of 6% today, we think the potential upside from rental growth and cap rate compression remains significant. And perhaps the strongest indication yet of Ireland’s recovery:
The volume of transactional activity in the Dublin pub sector during 2014 exceeded all expectations. In total, more than 38 Dublin pubs sold during the last 12 months with a further 19 under contract at year-end. With considerable deleveraging still to occur and the underlying economic recovery boosting consumer sentiment and in turn the pub trade, strong volumes of transactional activity are expected to be witnessed in the pub sector again in 2015.
– March 6, 2015
In our Annual Letter to investors we highlighted the collapse in the long-end curve as an indication of a maturing economic cycle (chart below):
Our friends at Variant Perception, recently shared a similar perspective:
A yield curve inversion has predicted every US recession since 1945, with only one false positive, in 1966 (although the false positive preceded a downturn in industrial production and a 25% decline in the DJIA). If you were a castaway on a desert island and you could only take one economic indicator with you, then you would take the yield curve. Last year, not one major economy’s yield curve steepened, and the pattern is continuing into this year.
Almost all major yield curves have flattened over the last 50 weeks. This is despite many central banks cutting or being in easing mode to try to combat falling inflation. When longer-term yields are falling relative to shorter-term yields, it is normally a signal that the economy as a whole wants to borrow less, and that the economy is slowing. Yield curves today are telling us global growth will slow in 2015. There is only a small recession risk at the moment, but continued flattening of yield curves would be a warning sign that things are due to get worse.
In addition to collapsing yield curves, global earnings momentum has slumped in recent months. While the energy sector has been a key source of these downgrades, revisions in US forecasts last month were the worst since the 2009 financial crisis. As illustrated below, the six month decline in forward earnings estimates is normally associated with a recession.
A few last points to ponder compliments of Andrew Lapthorne at Societe Generale:
It is fair to say that the consensus does not expect a US recession any time soon. As such the recent drop in consensus earnings expectations is being dismissed by many as attributable to weak energy prices and the translation effects of a stronger US dollar – two factors that will ultimately lead to cheaper prices in the US and a greater disposable income for consumers worldwide.
That may indeed be the case, but the counter-evidence is certainly mounting up. For one, if global economic acceleration was on the cards, why have 20 central banks cut interest rates already in 2015? Why have the economic surprise indicators fallen away, and why are most other countries also seeing major earnings downgrades – surely they should benefit from higher US dollar translation effects?
Posted in Macro.
– March 1, 2015