Week 150: Stepping Back a little

Portfolio Performance

See the end of the post for the current make up of my portfolio and the last four weeks of trades.

Recent Developments

For the last number of months I have been increasingly uncomfortable about being fully invested.  Throughout the amazing rally that we’ve had since the beginning of 2012 I have been haunted by the idea that the rally is a liquidity induced euphoria .  In particular, I am given humility by this chart.

Twice the quantitative easing policies of the Federal Reserve have ended and twice the market has gone into a tailspin.

The reality is that if the market falls hard many of the companies I own are going to fall too.  Small cap’s invariably get hit worse than the market.  Businesses that are in transition, which is where I like to play, may take an out-sized hit.  The companies I invest in are often mis-priced (in my opinion) because they are difficult to pin a value to.  This works in my favor as the market comes around to my way of thinking but it can also work against me; as the market prices in more risk its very easy with these sorts of companies to come up with a negative diagnosis. By way of example, take an old favorite of mine, MGIC: at its worst you could justifiably conclude that it was worth anywhere from $10 to $0 depending on how you wanted to weight the potential outcomes.

For this reason I am not a proponent of buy and hold.

In fact already we have seen small caps under-perform.  The Russell 2000 is down nearly 10% even as the S&P sits flat.  The stocks I own are generally better represented by the Russell 2000.  In this regard I have done well; in the last few weeks my portfolio is only off a couple of percent, and would be up if not for Yellow Media and magicJack.

But I am concerned that as summer hits the waning of quantitative easing will really begin to set in.  In the first quarter the tapering was from a high base.  In the second quarter the seasonal receipt of taxes by the government creates a natural lull in the need for borrowing by the government, which mutes the impact of further reductions in QE. But come the third quarter as tapering winds down, we may start to feel more of an effect from tightening.

This week on Wednesday and Thursday I sold enough stock to raise about 30% cash in my portfolio.  That was probably too much too fast, and on Friday I allocated some of that cash back (to Chipmos, Air Canada and new positions in King Digital and Hercules Offshore) but even so I have 20% cash level right now and I plan to increase that as opportunities arise. I also intend to be very careful about what I invest in; in particular, liquidity will be at a premium.  I want to own stocks where the daily trading volume is multiples of the number of shares that I own.

I have done incredibly well riding the wave of the bull market but I don’t intend to give that back by pressing for dollars when I should be preserving them.

On Wednesday and Thursday I exited positions in ADF Group, Rogers Sugar, DSP Group, Dex Media, Equal Energy, New Residential and my Hovnanian preferred shares.  In the prior weeks I had already exited Arbor Realty and Syncora Holdings.  The number of stocks in my portfolio has been reduced significantly.

I want to talk about some of the remaining names in my portfolio.

Air Canada

I was pleased with Air Canada’s quarter.  I initially reduced my position on Thursday by about 10% because I was taking the cutting knife to pretty much everything.  But after review of the quarters results that night, I decided to add back those shares, which I was lucky to be able to do at a lower price.

I think the market’s muted response to earnings was A. because the stock had already risen significantly when the company pre-announced their updated guidance back in March and B. because the first quarter is seasonally weak, even good numbers look back, and the company lost 50c per share for the quarter.

Everything I heard on the conference call (I listened to it 3 times) and read in the release was positive.  Demand going into the summer is strong all around.  Cost reductions are continuing apace and the company released improved cost reduction guidance for the year.  If things keep up in a similar manner for the rest of the year I am confident I will realize a double digit sales price in Air Canada at some point in the fall or winter.

Chipmos

Over the last few weeks I have increased, decreased and then on Friday increased the size of my position in Chipmos again.  My waffling is because I like the valuation, I like the arbitrage (which I discussed here) but I don’t like the high CAPEX, commodity-like contract manufacturing business.  So I’ve been trying to find a price I’m comfortable with and I think with the recent drop I’ve done that.

The first quarter was very good, the second quarter guidance was very good, and while the price of the Taiwanese exchange traded entity traded up above 40 last week, the Chipmos ADR traded down to nearly $21 on Friday.  That is a 20% arbitrage.

It is a bit of a trade.  I think this arbitrage is too large and I can’t see a lot of negatives coming out between now and the release of the second quarter results.  Meanwhile as the Taiwanese entity continues to gain exposure, its reasonable to assume its price should trend upward.  So I think its a fair bet that ChipMos trades to $25 at least in the next few months.

Extendicare

I talked about Extendicare in my update last week.  I increased my position in the stock somewhat on Thursday, on a day when I reduced my positions in pretty much everything else.  I really like that the situation is likely to resolve itself in a little over a month, and more recently, I really like the way Skilled Healthcare is trading.  A quick look at the chart demonstrates that Skilled Healthcare has broken out, including a big up day while the rest of the market tanked on Thursday.  Skilled Healthcare is probably the closest proxy to Extendicare’s US operations; both operate almost exclusively skilled nursing operations.  the interest in the stock gives me a little more confidence that a separation of the US operations of Extendicare will be accretive to the current level of the stock price.

magicJack

Sigh.  I have been long and wrong on magicJack.

I nominally sold down my position in MagicJack, by about 10%.  Over the weekend I listened to the first quarter conference call a number of times and stepped through all the prior conference calls since the beginning of 2013.  I get the bear arguments, which are:

1. Total activations and net customers have weakened for two quarters
2. The company is spending a lot of money on the hope of increasing sales through the new marketing approach
3. The second quarter is going to be weak
4. In the long run we may all transition away from traditional phone numbers to some sort of app based, WIFI powered calling method that will render the device obsolete

I also get that management hasn’t delivered on all their promises.  In particular, after reviewing the conference calls, messaging was supposed to be in the app by year end 2013, Latin America was supposed to occur around the same time, and the iTunes app was supposed to be out in April.

Yet I still hold.  I think there is a market for a service where the same number can be used at home and on your cell.  I think that magicJack has a better app product for voice services than the competition (Skype, WhatsApp, Viber) because it provides free calling to landlines in addition to other devices with the same app.  I remain optimistic that a well placed roll-out in Walmart and Best Buy can drive sales (I know that in the BestBuy near my house that the current location of the magicJack product is hidden among other electronic trinkets and virtually invisible if you were not looking for it).  And I think the initiatives announced around Latin America and messaging (which is scheduled now for the latter half of this year) have promise.

I originally bought the stock in the $12’s, but I added at $21 and again in the $17’s so my average cost is right at the current price.  Though I still like the idea, I’ve set my stop on the stock, which is the loss I’ve deemed acceptable.  If it continues to drop I will reduce my position further.

Portfolio Composition

Click here for the last four weeks of trades.