The 1st half of 2017 has been the polar opposite of the 1st half of 2016. Where last year we saw massive market declines in January and late June, this year we have seen no material selloffs, and minimal volatility. Investor sentiment has changed from primal fear in early 2016, to incredible market optimism and frankly greed.
We are now more than 8 years into this bull market, making it one of the longest in history. For the first 4 or 5 years, it was the most hated bull market and it took much longer for a majority of market participants to get fully invested than in prior bull markets. Because so many people were late to the game in getting in on the gains, we have seen aggressiveness ramp up as they try and make up for lost time and profits. A prime example of the increase in risks are the proliferation of 100% long-equity index fund portfolios that we are seeing. I’ve said it before but now I’ll say it more forcefully, this is going to end disastrously!
Every bubble starts with a true statement that is then extrapolated way too far into the future:
- Quality companies deserve to trade at higher valuations.
- Technology companies will transform the world.
- Housing has historically been a great investment.
- Index funds tend to outperform most active investors and are very low cost.
All of these statements are true but when you completely ignore the relationship between price and value, you expose yourself to very high risks of permanent losses of capital. Institutional investors such as pension funds are finally realizing that many hedge funds aren’t worth their high fees, but they are overexposing themselves to equities when valuations are stretched. While I’m not a proponent of most hedge funds, the reality is that they can often perform quite a bit better in rocky or negative markets. We have seen how the index fund bubble ends and it is not pretty! From 12-29-1999 to 12-31-2008, the S&P’s cumulative performance including dividends was a loss of 27.83%. If you buy too high the results are not good.
When the stock market is in an 8-year bull market, you’d have to be a pretty terrible investor to not make money. Fortunately, at T&T Capital Management, we have outperformed the S&P by a considerable margin but our goal in bull markets is really just to try and keep up. Long-term outperformance comes from how you handle the eventual and guaranteed major downturns.
Short-term selloffs are impossible to consistently predict so by sticking to a value framework and not panicking, one should be able to recover.
What is more difficult is being able to resist the seeming safety of crowds and be willing to leave the party before everyone gets too drunk.
It is virtually impossible to consistently time the market and as deep value investors we have a huge advantage by being able to focus on the undervalued securities, instead of exposing ourselves to the market as a whole when it is overvalued.
In addition, our utilization of tools such as selling cash-secured puts enables us to be able to still participate on the upside at a competitive rate, while dramatically reducing our risk relative to the 100% long stock portfolio.
We are still finding investment opportunities that we really like including the following
- Undervalued REITS yielding 10-12%
- Financials growing intrinsic value by 10% per annum including dividends and selling for a 20% discount to liquidation value.
- A special situation that we believe has 70/30 to 60/40 odds for success that would return 500% if we are right.
- An undervalued retail operation yielding greater than 7%, with 50% upside, trading at a discount to a conservative estimate of liquidation value.
- High-yield bonds yielding 17-18% annualized on what we believe should continue to be a performing bond, or at worst, should be the fulcrum security in a restructuring offering upside in the eventual conversion from debt to equity.
You can’t judge an investor by simply measuring performance without understanding the risks involved in obtaining that performance. Does achieving market returns with the same level of risk, warrant a pat on the back? Just the same, does outperforming in a bull market taking way more risk mean someone is a better investor? Of course not.
Our goal is to produce outsized long-term returns while also taking less risk than our competitors, including the overall market. Now is not the time to obsess about maximizing every percentage point of gains, but instead we want to do well, while still protecting ourselves from the next major downturn. By doing this it should reduce our downside exposure, while also allowing us the capital and wherewithal to get more aggressive, and take advantage of cheaper prices during and after the downturn.
Below is a little video that we made which answers some common questions that we get and tells you a little more about our firm: