What a day, with both the S&P and Dow Jones indices declining by over 4%. From the highs hit a week ago, the indices are down over 8%. This isn’t very shocking to us as we’ve been concerned about the markets for quite some time, which is why we’ve used less aggressive strategies such as covered calls and cash-secured puts. In addition, our largest positions are special situations, meaning that our long-term results on them shouldn’t necessarily correlate too highly with the overall market. One day doesn’t make a trend, but it isn’t surprising to me that AGO was up based on the good news we wrote about earlier. We have several large positions with catalysts that should play out over the next 6-12 months, and the business fundamentals wouldn’t change at all even if stock markets aren’t as favorable.
While today’s down day was significant, since 1997, we have had 32 percentage declines greater. It has been a while though as we haven’t seen this type of one-day decline since August of 2011 during the European Sovereign Debt Crisis. The S&P VIX or Volatility Index, is up 187% since February 1st. This is significant in that it shows the level of fear that has come into the market. Option prices go up when this occurs, causing short-term mark to market losses that are not economic as we let our options get closer to expiration. On the plus side, this greatly increases the amount of premiums we can generate by selling puts on value stocks. Typically, higher volatility augurs well for our future returns.
“On the plus side, this greatly increases the amount of premiums we can generate by selling puts on value stocks. Typically, higher volatility augurs well for our future returns.”
There are a few things I want to caution you on. During these periods, there is nothing more worthless than the commentary you see on CNBC and Bloomberg etc. They are almost always highly reactionary and short-term oriented. This is not helpful to anyone except to try to drive ratings. Today I saw a lot of commentary on stocks being on sale after these major declines. While they are indeed cheaper, they are far from cheap.
This is why I have been warning against index and mutual funds that are 100% long the market and are weighted towards the most expensive stocks. If I could only buy index funds, I wouldn’t buy today just because we are down 8% from the highs. The portfolios we hold are very different than the overall market. Nearly all of our large positions either trade at material discounts to tangible book value, or at less than 10 times normalized earnings. Our portfolios on average, have higher dividend yields than we have ever had since I started T&T Capital Management. We’ve been able to take advantage of the decline in real estate stocks over the last year, to find some very compelling bargains with yields varying from 5-15%. Obviously, you aren’t going to get a 15% dividend without the company having some hair on it, but we feel very good about the future prospects of these businesses. Not only should we get paid for waiting, we should see considerable appreciation on them.
I’ll end this article with a little advice I’ve learned over the years, if you are a passive investor and aren’t trying to buy or sell stocks on the given day; Keep a long-term focus consistent with your goals. Any one day, month, or even year, shouldn’t be overemphasized or obsessed upon. If you get stressed in crazy markets, go outside and breathe in the air or do something to take your mind off it. Major fluctuations are 100% inevitable, so getting fussed about them doesn’t make a ton of sense. The last thing you want to do is get emotional about investing, as that is when people make the big mistakes.
“Keep a long-term focus consistent with your goals. Any one day, month, or even year, shouldn’t be overemphasized or obsessed upon.”
You didn’t see us getting more bullish as stocks went up and our outlook doesn’t change just because we are finally seeing overdue volatility. Our focus is always on valuations and fundamentals. Prices are expensive, but not for the stocks that we own, because we have been wary about the potential for a reasonable selloff in the market for quite some time now. It is true that the overall economic fundamentals are very good. Earnings growth has been tremendous and will get better with the tax cuts. This good news is priced into the market though, so more volatility should not be a major surprise or a major concern as long as the U.S. economy holds up strong, which I believe it should for the next 12 months or so at least.
Hopefully some of you find this helpful. For you longer-term clients, you know this is when things get a little more exciting for us as we are able to pick up some bargains when things get chaotic. If you’ve had some cash sitting on the sideline, now is probably not a bad time to start to add as the increased volatility is incredibly helpful for our cash-secured put strategies in particular. As I said before, I certainly wouldn’t say this is a bottom or anything like that necessarily for the overall market, so if you have a fund portfolio elsewhere you are concerned with, please don’t hesitate to contact us as we have no problem giving you a free portfolio review as part of our service to you as clients. Thank you very much!