What a difference a change in the calendar can make! The end of 2018 saw some of the worst declines we have seen since the Great Recession, but 2019 has started off extremely well. Far more importantly than short-term stock performance though, are the earnings developments from the companies that ultimately drive long-term performance. This week marks the beginning of earnings season, with the big banks reporting their results for the 4th quarter of 2018. Thus far, the results have been nothing short of outstanding. Earnings per share are way up due to the benefits from the tax code, higher net interest income, and lower shares outstanding. This has resulted in massive benefits to shareholders and the future is very bright. Credit quality remains pristine and by some measurements is better than it has ever been! Underwriting is far more strict. When the next recession comes you aren’t going to see the same credit losses as we saw a decade ago, because the businesses are dramatically different. Many analysts and market participants do not realize this, which gives us an advantage.
“The end of 2018 saw some of the worst declines we have seen since the Great Recession, but 2019 has started off extremely well.”
Management commentary through all of the big banks has been relatively optimistic on the economy and credit. Business conditions could certainly be better, as the uncertainty regarding trade, Brexit, and the government shutdown are not positives for confidence. However, the economy is still growing and there could be potential upside beyond that if we get favorable resolutions to these key issues.
Over the last several years, we at T&T Capital Management have harvested massive capital gains on the big banks, which were some of our largest positions for years. In some cases, the banks traded higher afterwards and some people felt like maybe we sold too early. In our estimation, the prices had risen to levels where we no longer had as big of a margin of safety, and we had other opportunities with more compelling risk-rewards. This recent decline allowed us to load up via stock purchases and cash-secured put sales. Already these stocks are meaningfully higher, but they have a long way to go before they are fairly valued. What is great is that they are returning nearly all of their earnings to shareholders via dividends and stock buybacks. They are able to do this because they have the strongest capital ratios in history.
We have no idea if the market will continue to trend higher or if it will test the lows again, as that is something that nobody can accurately predict consistently. What is amazing though is how quickly sentiment and strategy changes for so many market participants. Those that talk about long-term investing, all of the sudden turn into chartists when times get tough. People look at the stock market as though it is a fortune teller for the economy. Just because the market was down, things had to be going to hell on main street. The fantastic December jobs report did a lot to quell those concerns, and the Federal Reserve has taken a more dovish stance to let the economy dictate future rate decisions, instead of a preordained script.
Short-term trading sounds like a great idea, but time and again it leads to disastrous financial results. There are virtually no old and successful short-term market timers, but there are countless successful long-term investors. Finicky moves trying to time the market or follow a chart pattern are the opposite of intelligent investing. The reason we are able to capitalize on big moves in prices is because we dig deep into the fundamentals of the companies we own. We understand the businesses and the drivers of earnings, as well as the risks that are there. This allows us to take advantage of the disconnect between price and intrinsic value, instead of panic selling and then missing the ensuing rally, which is what happened to many market participants.
“The reason we are able to capitalize on big moves in prices is because we dig deep into the fundamentals of the companies we own. We understand the businesses and the drivers of earnings, as well as the risks that are there.”
One other unappreciated aspect of our strategy is that by utilizing cash-secured puts and covered calls, we are able to monetize gains in positions much easier than by just owning stocks. We can buy back our options at any time after we’ve realized the majority of our target profit. Sometimes this means making less money than we would have made having bought the stock, but it allows us to load up each time the stocks drop in some market selloff, leveraging our research that much more. Many people made a fortune on FAANG stocks for instance, but they kept adding at higher prices, and then they panicked after the stocks tanked. The hardest part about using puts in particular is that you have to allow time to elapse to see the full benefit. Many of our current options expire in January of next year, so there is a lot of unearned premium, which should really help our account values as the year progresses.
I must give a shout out to our amazing clients at T&T Capital Management. Despite a 20% drop in the overall market, not one client panic-sold. I cannot tell you how rare that is in our industry and it has increased our respect level that much more. When markets are tanking and everyone is losing their heads, that is when buying delivers the best value. Simply not panicking adds so much value between you and the average investor. While doing nothing might not seem like an accomplishment, it is actually a huge one in the investment business. As Charlie Munger says, “The big money is in the waiting.”
This is a busy time of year with earnings coming out, so I’ll be doing my best to provide updated research and commentary. We are really excited about 2019 and the next few years. The 4th quarter of 2018 was frustrating in that it put a dent on what was a fantastic year, but the reality is that the seeds have been planted for us to materially grow our wealth, and we are committed to seeing that through.
As always, thank you so much for your trust and faith in us. We are invested in the same stocks and strategies as you are, so we are in the same boat. If you need anything at all, please don’t hesitate to ask!