With 2011 coming to a close I think it is very important to lay out our views going into 2012, and how that will affect our investment strategies. 2011 was a very difficult year that saw some of the most successful investors Warren Buffett, Bill Gross, Bruce Berkowitz, John Paulson, Martin Whitman, among many others struggle. The beginning of the year started great continuing upon a strong 2009 and 2010 for stocks, and the US economy actually did okay, but the markets took a huge turn for the worse in the Spring and Summer and never really got going again. International stocks did far worse in general than pure play domestic stocks and the best asset classes to be in were Treasuries with long term yields less than 3%. In 2011 we endured a bear market in equities, severe worldwide political turmoil, the uprooting of several major Western European governments, a huge natural disaster in Japan, amongst many other issues.
In 2012 we expect Europe to continue to be a lightning rod for the markets, but we are encouraged that it is clear that the governments in both Europe and elsewhere are committed to fixing the problem. In our opinion they haven’t taken the steps that will eventually be needed such as printing money at the ECB, or guaranteeing Eurobonds, but we feel that prices reflect these anxieties fully in many sectors such as the financials. In late 2011 we have seen some encouraging data on housing as inventories have declined, but to see sustained improvement we believe it will be necessary to see looser credit markets, and increased consumer confidence. When housing stops acting as a drag on the economy, I believe you’ll see tremendous benefits in terms of employment and confidence that is not fully appreciated or expected by the market.
From a valuation perspective stocks are extremely cheap, particularly when compared to other asset classes. If the worst case situation in Europe does not occur I would expect a strong rally by the end of the year. Well financed and profitable companies such as a Citigroup or JP Morgan do not trade at fractions of tangible book value for very long, and the disconnect between price and value for the financials has never been so severe for this long. The banks and insurers such as MET and AIG have the potential to double or triple over the next 3-5 years. Even if some of these companies were to double over the next year they still wouldn’t be overvalued as that would just bring them to about book value, meaning you are getting any growth or franchise value for free. To catch the really important bull markets in sectors or stocks, you almost always have to be early and very contrarian as those that invested in commodities in the last decade, homebuilders in 2003, and healthcare stocks the last couple of year can attest to.
Oil prices have been hovering around $100 and we believe that the development of the United States shale reserves is having and will continue to have a transformative impact on global energy markets. Due to the abundance of natural gas supplies we see prices staying low to the benefit of chemical and utility companies, but to the detriment of those that are relying on too heavy of a concentration in natural gas production versus oil. Services companies such as Haliburton will be primary beneficiaries of this movement, and we believe that they will see a cyclical expansion on their return on invested capital over the next 3-5 years.
Companies such as BP and RIG which have struggled for the last several years with lawsuits and regulatory changes, should finally begin to get most of their problems behind them which should lead to higher stock prices. BP’s business has been going great and we expect their continued earnings growth and dividend raises to be the primary catalysts, while for RIG it will take a bit longer for them to get their Rigs updated with the newest regulatory mandates before you see their true earnings power in 2013. RIG is a company that has earned in excess of $10 per share with oil prices near their current levels so with the stock trading below $40 you are getting a 25% earnings yield on normalized earnings, assuming you believe oil prices aren’t likely to plummet. Large cap technology stocks such as HPQ, MSFT, CSCO, INTC, are trading at all-time lows as far as valuation goes. These companies have very strong balance sheets and are likely to continue growing at reasonable rates over the next 3-5 years. It would be very constructive for these companies to aggressively buy back stock and improve their dividend payouts, as they are no longer the high growth stocks that they historically have been. Better capital allocation would be greatly appreciated by the market and would lead to multiple expansion.
From a strategic standpoint it is important to maintain a long term investment philosophy. This will translate into owning more equities so as opposed to selling more puts on stocks so that you are maximizing your upside potential. The conditions going into 2012 aren’t much different than what we saw in early 2009, in that stock pricing does not adequately reflect the business values, and a simple reversion to the mean can lead to explosive returns. As stocks rally we will intertwine more covered calls to lock in profits and to generate additional cash flow. The market punished risk assets in 2011 to the benefit of perceived safe havens such as treasuries, but from an investor’s point of view equities are really the only place to be at current levels. Double digit earnings yields and all time low levels of price to book value augur for an exciting 2012. We must keep in mind that we are investors and not market timers. We are buying businesses and not just fractional shares of paper. Markets get irrational regularly allowing us to buy companies at great prices, but timing those movements has proven to be futile for the vast majority of investors over time. The key is staying the course and allowing the time it takes for stock prices to converge with the business values.
At TTCM we are 100% dedicated and committed to helping you and your families reach your investment goals. While we can’t guarantee returns or expect to outperform every year, we can guarantee that we will work every day to give us the best opportunity to help you meet those goals. We will always deal honestly with you and we invest our own money in the same types of companies and strategies that we do for our clients. We run more concentrated portfolios following a deep value investment methodology which means that often your returns will be lumpier than in a mutual fund. This can be painful over short term periods especially given the fear and anxiety that is currently present, but it has proven to be the best course of action over time. I personally have been in the industry for about a decade and I take pride in being an amateur historian as far as financial markets go. The biggest reasons that I have witnessed for people losing money is by following the herd, and panicking at the wrong times. We are committed to staying the course and are really excited to see what the next couple of years will bring. Based on history, future returns should be quite a bit higher than past returns due to the cheap valuations that exist, and we will continue to seek out the best risk adjusted opportunities. There was a time not too long ago where 15-20 times earnings was seen as pretty attractive for a value stock, and the opportunities to buy great franchises at the levels we are buying them currently would cause the value investor to salivate. We stand ready to take advantage of this mispricing and I can tell you that I’ll be looking to invest as much of my own free cash flow as I can into the markets, because when the outlook gets brighter you will pay a far more dear price.
INVESTING IN THE FINANCIAL MARKETS INVOLVES RISKS. OPTIONS ARE NOT SUITABLE FOR ALL INVESTORS.