There has been a tremendous amount of news over the last few weeks with the phase 1 trade deal with China, progress on the successor to NAFTA, and the Tories winning in the UK by a wide margin. We don’t want to overthink individual political or economic data-points, which is a mistake that far too many make. Our goal is to make money via buying undervalued securities. Often we do this by taking advantage of others panicking out of good securities, based on short-term concerns, enabling us to buy them at a large discount to intrinsic value.
I think the best way to think about trade with China is as a cold war of sorts. The relationship has changed and it is tough to put that genie back in the box, and I personally don’t think it is in our best interests to do so anyways. The phase 1 deal should at least ease anxiety and reduce the probabilities of an escalation, while helping U.S. farmers export their goods. Any more substantive phase 2 deal would only be likely after the 2020 election, or if it was very obvious that the current administration would win again, as the negotiations would likely be tougher in that scenario. As it relates to TTCM, we don’t have much exposure in this area, although clearly we benefit from better global growth, and less economic turmoil.
The UK election was a very material event in that it means we should finally see Brexit occur. The key is, it should resolve the major uncertainty that has been hanging over the UK and the EU for the last three and a half years. We have seen major gains in our sizable European bank positions, including Barclays, Lloyd’s, and BNP Paribas. These were perfect examples of how we like to invest. We bought both Barclays and BNP at massive discounts to tangible book value, with an earnings yield in the teens, and very attractive dividends. These are very profitable and financially strong companies that were just drastically out of favor. Predicting the timing of when prices will converge with intrinsic value is always difficult, but experience has taught us that eventually it does occur. We’ve held on to many of these positions, although we’ve locked-in a lot of the profits on Barclay’s put options after its rapid rise. If it drops again, we could easily resell again for higher premiums.
BMW, Daimler and Fiat Chrysler, have also been very strong positions for us. Once again, we found more attractive values in these European stocks, during their recent period of under-performance. These stocks are still really cheap and while they are facing some economic headwinds in China and the EU, over the long-term they still have quite a bit of upside.
Speaking of Brexit, it is interesting to go back to that vote in June of 2016. The market tanked the next day and the banks in particular were pulverized. Many pundits said they were un-investable, and at the time, they were some of our largest positions in our portfolios. I’m happy to say that Bank of America has basically tripled over that time, while Citigroup has more than doubled. Time and again we have been able to take advantage of these types of panics. This is why the one thing we are adamant about with clients is to never get scared out of positions when we are taking short-term mark to market losses. Our strategy has multiple layers of protection, but the whole key is letting time play out with the options, and with the realization of intrinsic value.
Assured Guaranty, which has been our largest position over the last few years, has had a heck of a run despite Puerto Rico’s historic and lengthy default, and an aggressive short-selling campaign by billionaire David Einhorn. The stock is over $50 per share as we write this. As our already large positions go up dramatically in price, they become a very large weight in the portfolio. There are times when we will trim down via the utilization of covered calls or simply selling some stock. Most of the time we have done this, we have been able to get back in at much cheaper levels during a time of market turmoil.
This is not a time when we want to be super-aggressive! Market prices are elevated, but there is still upside potential, especially with bond yields being so incredibly low. We are constantly de-risking and adjusting our positions; which means selling stocks when they get more expensive, and buying them when they get cheaper. Most of our activity is selling cash-secured puts, as that is our most efficient way to manufacture cheaper entry-prices into stocks, providing a cushion if we see a downturn over the next 12 months or so.