Week 432: Where My (tenuous) Conviction Lies

Portfolio Performance

Thoughts and Review

Writing about the broad market makes me uneasy.  I fully admit I do not have any edge to it.

Yet I necessarily have to take a position on the broad market, and this blog is about why I make the decisions I do.  So regardless of whether my point of view is naïve or uneducated, I still need to describe it.  If only for my own posterity.

With that disclaimer, I want to briefly explain why I continue to be cautious on the market even as we approach new highs.

First, caution is different than being bearish.  I am not bearish right now.  I’m still long many stocks.  My longs are roughly double the value of my index shorts.

I am probably not enough of an expert about the macro-drivers of the market to be truly bearish on it at this time.  Its too ambiguous to me.

Instead I stick to my knitting – I go long individual companies that I can definitively say I am bullish of.   At times, depending on my level of trepidation in the market, I hedge the overall exposure to varying degrees. The bigger the hedge, the more cautious.

Right now, I’m more hedged than usual.

Consider the charts of the following stocks:

When I look at the three sectors that underlie these six charts (SaaS, pot stocks, oils), I don’t see much in common.

Debt issuance is a priority for oil companies.  Stock issuance for pot stocks. Most of the SaaS names are self-sufficient.  None of the sectors these companies operate in have much in the way of overlapping fundamentals.

The only thing I see in common is A. the chart pattern.  The charts are all miserable, and B. these are the sort of stocks that are driven more by speculation than most.

Of course, I am cherry picking sectors that are under-performing.  I could take the charts of Texas Instruments, Taiwan Semiconductor or even Apple and paint an entirely different picture about the market as a whole.

But that is kind of the point.  It is my suspicion that these poorly performing, uncorrelated sectors are signs that liquidity is a little more scarce than it typically is, but not necessarily scarce enough to a worry the whole market just yet.   We are left with rolling bear markets in some sectors, while the overall market holds up.

I have been railing on about tightening liquidity and worrisome economic signs for some time now.

Maybe I shouldn’t.  I certainly don’t understand all the machinations.  But there are a few general principles I have learned, and that I will continue to stick by so long as they work more often than they don’t.

My first five years of investing were from 2004 to 2008.  During that time my Dad was a BMO client and as such I was a faithful listener and reader of their head strategist – Donald Coxe.

Coxe put out a monthly publication called Basic Points and did weekly calls each Friday.

Donald Coxe was quite a good strategist.  He wasn’t perfect of course, and some of his views have turned out to be wrong, but many were right and he caught a number of very good investing trends.

One of Coxe’s favorite metrics to gauge the state of the financial system was the TED spread.  This was the difference between interest rates on three-month futures contracts for U.S. Treasuries and Eurodollars with identical expiration months.

Coxe followed this spread with interest, and when it rose unusually high, he said it was a time to exercise caution in the market.

He did not pretend to understand all the dynamics that may be moving the spread.  In fact, he often admitted it was an opaque market.

What he did know was this – that the spread was correlated to liquidity, and when liquidity was less abundant bad things were more likely to happen than if liquidity was loose.

What bad things?  Who knows!  It was and is (I think) kind of futile to try to predict what might be the lynch pin.  You just look silly most often.

The lesson here is more about the concept and less the particular indicator.  The TED spread doesn’t seem to work like it once did and I am not entirely sure if there is a single indicator that has taken its place.

Nevertheless, there are some signs the last few months that suggest liquidity is less abundant that it was 6 or 9 months ago.

One of the signs are these rolling bear markets that are hitting sectors that you might consider speculative.  In my experience rolling bear markets in such sectors can preclude downturns in the index as a whole.

We saw something of the sort in 2015.  In August of 2015 I wrote:

When I raise the question of whether we are in a bear market, its simply because even though the US averages hover a couple of percent below recent highs, the movement of individual stocks seems to more closely resemble what I remember from the early stages of 2008 and the summer of 2011.

The move down in the index didn’t occur until late 2015 – early 2016.

In all honesty, it doesn’t feel quite as bad now as it did in mid-2015.  So we are likely further away from a move of the averages, if it happens at all.  Nevertheless, the chance that something like this may occur again has been my caution since the late spring.

There are reasons to believe my caution will turn out to be wrong.  Some have talked about signs that the economies of Europe and China are bottoming.  There is maybe some sort of trade deal in the works between China and the United States.  The Fed is loosening in one way or another. So is the ECB.  The weekly leading indicators in the United States have been trending up of late.

Nevertheless, I still think I am more comfortable taking a cautious bent.  When I look at the performance from the funds letters I have read, I see some numbers that, while very good so far this year, showed -15%, -20% or even -25% in the fourth quarter last year.  I would not handle such losses well, so I prefer to take the cautious road.

If I am wrong it will hurt my performance a bit.  But if I am right in my stock picking, that should more than compensate for the mistake.  Thus far, it hasn’t really helped my performance, but it hasn’t hurt it either.

It is the individual positions that will make or break my portfolio which is how I want to position things.  So, let’s talk about a few of those ideas.

Tankers – I waffled back and forth a bit, but I finally sold the last of my tanker trade this morning.  I unloaded most of my position a few weeks ago, but as seems to be the case with ideas I’ve tied myself to for a while, its never a clean split.  It may still not be, but I want to see an entry that is not so elevated and over-bought to interest me.

Schmitt Industries – My most recent purchase.  I wrote about it here.  This stock has been slowly working higher, but my best guess is that it does nothing until the next step in their restructuring is announced, which could be months away or could be tomorrow.  I do not know if or when more assets will be sold but given the activist nature of the new CEO, I suspect they will be at some point.  With cash still making up most of the capitalization I will patiently wait.

Evolent Health – I wrote about here.  We will likely get some resolution on Passport Health Plan in the next few weeks.  Interestingly, Piper wrote their thoughts on Passport a couple weeks ago.  They were quite positive.

Nuvectra – I wrote about here.  My entry in this one was poor, but I added to it after it fell into the $1.30’s and I am now in the black on the stock.  I am hoping (this one indeed has a bit of hope involved) that we hear a positive outcome of the strategic review in the next few weeks.

Vertex Energy – I most recently wrote briefly about Vertex here.  There is always at least one position in my portfolio that confounds my expectation.  Vertex is it for now.  In short order they should be a beneficiary of falling HSFO prices (the futures curve, where prices were as high as $50-something per barrel as recently as September, is setting up just as I had hoped) and that should mean blow-out margins.  However, one might expect the market to anticipate this and it is not.  So I am puzzled.

Gran Colombia Gold, Roxgold, Wesdome – My primary gold stock holdings.  They have all corrected over the last month.  Roxgold in particular has seen a rather dramatic plunge.  They all have their own nuances, but they will all move up or down along with gold and the state of the financial system which I guess is a hedge in itself.

To balance my long portfolio, I am keeping a higher than usual level of hedging by way of inverse index ETFs.  As well I remain short a few individual names.  My shorts are the same as they were at last mention – a few SaaS names, a couple biotech’s with questionable histories, a couple of cannabis names that are levered to a Canadian extraction market that appears to me to be very oversupplied, a couple of US shales that are seeing their access to debt dry up and that I believe will struggle as a result, and a couple of Canadian banks that I will continue to be wrong about.

Portfolio Composition

Click here for the last five weeks of trades.