Dear Investors,
The 4th quarter of 2018 was truly fascinating from the perspective of investor psychology. In the beginning of the downturn, most market participants were still quite optimistic that it was just a temporary setback in a bull market. As the quarter progressed and the selling picked up steam, the psychology turned to fears of a massive bear market and recession. Unsurprisingly, investors poured out of mutual funds and index funds at a record pace, despite the facts that stocks had gone on a significant sale. Moving forward to the present, we just experienced the best January in 30 years, with the S&P up 7.9%. Think of how frustrating that would be to have gotten out of the market after taking a huge hit, locking in losses, only to see stocks stage a very strong rally right after the fact. I’m glad we don’t have any clients in that position, as not one TTCM client panicked, which is an amazing testament to your intelligence and self-control amidst turmoil.
Many times during my career, I’ve been criticized by the fact that we don’t use stop losses from outsiders that don’t understand our strategy. For those unaware, stop-loss orders are basically sell orders that gets triggered when a stock drops beyond a certain price. It sounds wonderful to “limit” your losses, but it is mostly theoretical and impractical if you have any idea of the fundamentals of the company you are investing in. Also, there is no guarantee the stock doesn’t dive below your stop-loss at the open, forcing you to lose far more than you expected. Below is a chart of Citigroup stock. The company has been growing its profitability each year, improving its financial strength, and has a great future. The liquidation value is likely in excess of $70 per share. The stock traded in the $70’s for much of 2018, but in the 4th quarter dropped below $50. Imagine having a stop-loss at $50 and selling your stock, only to see it rally to the mid-$60’s in just 1 month.
Many times during my career, I’ve been criticized by the fact that we don’t use stop losses from outsiders that don’t understand our strategy. For those unaware, stop-loss orders are basically sell orders that gets triggered when a stock drops beyond a certain price. It sounds wonderful to “limit” your losses, but it is mostly theoretical and impractical if you have any idea of the fundamentals of the company you are investing in. Also, there is no guarantee the stock doesn’t dive below your stop-loss at the open, forcing you to lose far more than you expected. Below is a chart of Citigroup stock. The company has been growing its profitability each year, improving its financial strength, and has a great future. The liquidation value is likely in excess of $70 per share. The stock traded in the $70’s for much of 2018, but in the 4th quarter dropped below $50. Imagine having a stop-loss at $50 and selling your stock, only to see it rally to the mid-$60’s in just 1 month.
Not understanding what you own and why you own it, or having someone you trust that does, is a major weakness for most market participants. For the last 5-years, we’ve been inundated with marketing on how amazing index funds are, and they are fine investment tools. However, it is nearly impossible to understand exactly what you own in something as diversified as an index fund. What is the real fair value? When you get massive psychological change like we saw in the 4th quarter, investors in index funds should be buying more, instead of selling in a panic. It isn’t enough just to buy the dips though. When the Nikkei Index peaked in 1990, investors that bought the dips have endured nearly 30 years of lackluster returns. The index still isn’t close to where it was in 1990. This pain would have been avoidable had they looked at the fundamental drivers of that bubble and the valuations that were implied in stock prices.
“It is nearly impossible to understand exactly what you own in something as diversified as an index fund.”
We are far from perfect investors. We make mistakes on certain stocks. Sometimes we sell too early and sometimes we sell too late. But by investing in a business-like manner, we always have a framework with which to view things and underline our decision making. Early in January when the market had rallied a bit, I was chatting with a friend, who is very knowledgeable and works in finance. The person is a huge bull long-term, but he became obsessed with technical analysis, and insisted that the market was destined to retest the lows hit in December imminently. This was a very common sentiment in the chartist community, where my exposure is mostly through Twitter, where I follow thousands of people to get exposure outside of my circles. This fear based on technical analysis overrode his belief in the fundamentals and prevented him from buying stocks when they were on sale. Now the person is frustrated and has been tempted to chase securities that have risen 20% over the last month. Arbitrary rules such as a stop-loss might make perfect sense for a trader that is not invested for fundamental reasons, but they make no sense for the long-term value investor.
Looking forward, we should be less bullish than we were in January. Many stocks have risen quite a bit and are no longer the no-brainers that they were a month ago. However, we are still optimistic on individual positions and the majority of our major investments still trade at discounts to book value and/or less than 10 times normalized earnings, which is insanely cheap.
“We are still optimistic on individual positions and the majority of our major investments still trade at discounts to book value and/or less than 10 times normalized earnings, which is insanely cheap.”
Ally Financial for instance, just reported strong earnings with adjusted earnings per share for 2018 of $3.34. Tangible book value rose to $29.90 per share, yet the stock trades around $26, or less than 8 times earnings. No analysts worth a salt think that Ally is all of the sudden going to start losing money even if we saw a significant recession. They probably will return about 10% of their market cap back to shareholders this year via dividends and stock buybacks. Buybacks are enormously accretive given the discounted stock prices and we expect solid EPS growth in 2019. While we love the stock and own it, we have a bigger position on cash-secured puts that we have sold. Most of these puts have a mid-teens target profit return and would give us breakeven on the stock in the low-$20’s. A lot of the ALLY stock we own was bought in the high-teens a few years ago. We sold quite a bit in the high $20’s or low $30’s in January of 2018, but have found opportunities to get back in during these selloffs. Even if one isn’t hugely bullish on the market, there are still many ways to make money but you have to know what you are doing and why you are doing it, otherwise you will be flying blind. Investors that are expecting the next 30 years to be the same as the last 30 years, are likely to be very disappointed. Still many investments will make fortunes for those that are willing to ignore the crowd and focus on intrinsic value.
January was a very good month for TTCM, and we are excited about the year and our long-term prospects. There will be setbacks, but those setbacks are what create the best opportunities to truly improve your financial position. Our team is laser-focused on helping you achieve the financial outcomes that you want and deserve, and we will work every day to make those dreams as realistic as possible. As always, please don’t hesitate to contact us if we can help you with anything!
Sincerely,
Tim Travis