Category Archives: Hot Topic Commentary

SWEEEEEEPPPPPP HAAAARRRDDD!!!!!!!

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Originally we were going to write about a disappointing Chinese PMI in conjunction with an improving US manufacturing situation and their macro ramifications, but watching Olympic curling changed our mind. Why? Because curling made me think about how investors may respond to changing macro conditions.

Unlike other ice sports, Curling does not have a Zamboni cleaning the ice between periods (i.e. ends). Therefore ice conditions change during a match affecting the stone’s speed and curl (direction). While changes in the ice are noticeable (often dramatically so) as the match progresses, this is just part of the game. As a result you try to predict how a shot will react in a particular condition. However, strategy—looking for opportunities for good stone placements—never changes.

This is a lot like investing.  There are a lot of changes to the macro playing field occurring constantly; but we usually have no idea to what extent those changes will impact the market in aggregate. Therefore how do we investors adapt to all these changing crosscurrents on our playing field? By ignoring them in the macro and paying close attention to them in the micro. It’s exceptionally hard to predict what a decelerating Chinese manufacturing situation may do to the US economy, but it is far easier to adjust one’s earnings estimates for companies that do or wish to do business in China, such as Emerson Electric, Yum Brands or Apple. If those estimates end up being outside your risk tolerance you can adjust your positions in those names accordingly, likely leading to aggregate changes in your portfolio that reflect these changed circumstances. This often leads to a better decision making process than a top down approach–trying to divine how a perceived macro change will impact a portfolio. Therefore I’ll leave the dramatic macro calls to the talking heads on financial networks.

So like curling, its better that we pay attention to our portfolios one shot at a time than trying to predict how playing conditions will alter the game in total. Conditions in curling ice, and markets, do change but you can make adjustments to your “game” so your tactics change but not your goal—making good shots.

Get Lucky

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The news in credit this week was dominated by the merger announcement between Comcast and Time Warner Cable – just in time for Valentine’s Day. Time Warner Cable bonds took a big hit last June, with spreads widening by about 150 basis points in response to romantic overtures from John Malone at Charter communications. Prices of TWC’s long bonds dropped by about 15-20 points, and have been languishing ever since on fears that Malone would prevail, and the company would lose its investment grade ratings. Comcast was an on-again, off-again suitor in this ménage a trois, and we wondered if they would ever take the relationship seriously. For credit investors who held onto, or took positions in TWC bonds during this drawn-out courtship, they finally got lucky. Immediately following the announcement of the all-stock deal, TWC bond spreads gapped about 125 basis points tighter, and the long bonds soared about 15 points. Not a bad one-day return for investment grade credit. One of the factors driving the deal seemed to be the desire on the part of management to pursue an all stock transaction, as it would help bondholders as well as stockholders. As creditors, we just aren’t used to seeing that kind of love.

Credit investors who held on during the January-end Emerging Market anxiety attack also got lucky, as spreads have tightened over the past week almost to the levels we saw before the mini-risk flare. Month-to-date excess returns are positive, and the long end is once again leading the way. We think part of the spread movement in secondary paper has been driven by a relatively light calendar, as the weather (and New York City weather in particular) continues to play an outsized role in our market. Taking out the Sovereign issuers, we were left with just $14 billion in supply, dominated by the bank sector with $4.25 of 3 year fixed and floaters out of JPMorgan, $2.75 billion 3 year floaters and 5 year fixed from Barclays, $1.75 billion 3 year fixed and floaters from Bank of America, and $2 billion from Cap One across 3 shorter duration tranches. If you did not want to buy short bank paper, you were definitely out of luck in new issue this week. Next week is looking better though – at this point there may be some pent-up supply, so we’re counting on at least $20 billion. If you’re willing to wait, you could get lucky.

Learning from our Most Painful Successes

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I think that every investor dreads the end of the quarter portfolio review—even when your quarter was successful.  Why? Because even in the best of quarters there are always the zombie stocks of your portfolio stumbling around for all to see.  We all struggle with defending these stocks to our peers and clients after they failed—even if the stocks were sold and it was the right decision to sell them at the time.  And we spend a lot of time analyzing these undead. All too often our successes go unanalyzed in these reviews because we attribute success to our intelligence, foresight and ingenuity of our investing process.  Unfortunately lots of avoidable future failures can be learned from our investment “successes”.

The Holy Grail of investing is developing a winning process that is unique, repeatable and sustainable. Achieving that goal means asking tough questions about success as well as failures. Investor hubris often comes from mistaking your intelligence for stumbling upon a bull market or your investing style coming into vogue for one’s clairvoyance. The key question, which rarely if ever gets asked, is what did you do differently this time that you did not do last time and is it repeatable? Equally as important is what insight drove you to that successful decision?  Why did others miss that insight? Will that insight continue to be overlooked? If an investor cannot answer those questions, success probably didn’t have anything to do with your stock picking skill. It probably had everything to do with luck.

Don’t get me wrong, luck is great as long as you can identify a particular success as such. It makes exiting out of a lucky position much easier of a decision. But again, achieving this takes some tough self-analysis and self-questioning, and not being afraid to admit to one’s weaknesses and misjudgments openly—even in the face of “success”.  Not always the easiest thing to do! Therefore long-term success means asking difficult questions about our winners as well as our losers. If they are truly winners, we can learn from them, incorporate what worked into our investment process and have (hopefully) even stronger results in the future.

We know how to question ourselves in our failures. They are there for all to see. Honesty is required in these situations. But good results don’t lie do they? Yes they do. Therefore brutal honesty is required here as well.

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You Gotta Know When to Hold ‘Em

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Disciplined Growth Investors

The inspiration for this article came from two blockbuster investment pieces published in the early 1980’s. The first was titled “The Greatest Financial Story ever told”, written by Greg Smith, the lead investment strategist for Prudential Securities. The second was titled “Revenge of the Nerds”, written by Stan Salvigson, a strategist at Merrill Lynch. Both titles were clever and a clear signal that these pieces were going to be different. And they were. Both correctly laid out the investment framework for the foreseeable future, a future in which financial instruments (primarily bonds, derivatives and stocks in financial service companies) would be the winning investments. Remarkably this strategy lasted until 2008, a span of over 25 years.

We hope to convince you that the U.S. financial markets are entering a new era, in which the key to investment success will be to invest in the stocks of winning companies at fair prices or less and hold them for long periods of time.

Innovative enterprises will be the champions of the new era. Their springboard for success will be their successful exploitation of the massive technological innovations which have been brewing for over thirty years. Enterprises must learn to think and behave differently in order to prosper in the new paradigm. There will be at least three major variables which will need to be addressed:

  • People – The winning enterprises of the future understand that their most important assets are their people. Long-term success will be contingent upon an enterprise’s ability to attract and retain the right knowledge workers. At a minimum, this means establishing a culture defined by a high level of trust and transparency.
  • Tools – Once the enterprise has the right people on board, they will need to provide the tools that help maximize individual potential. We define tools broadly to include both the devices and domain knowledge that will spur productivity gains. This means each enterprise must have a proactive stance toward new technology and the ongoing education of its personnel.
  • Systems – Finally, the winning enterprises of the future will understand that maximizing individual potential is not the same as maximizing the potential of the enterprise. To be successful, the organization must design and implement systems that act as a multiplier to individual contributions.  The most obvious of which is developing an innovation engine that leverages the collective insights of the organization

Read the full article

Wild Horses

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Emerging markets have taken center stage in the credit world over the past week, just in time to usher in the year of the Horse in China.  Here’s what we’ve learned about Horses: they are active and energetic and full of ambition. They are also hot-headed and impatient, and this sure felt like a week where the hot-headed prevailed. Fears about the potential impact of higher rates in Turkey, Brazil, South Africa, and other emerging economies had an obviously negative impact on equities, but also helped to push Treasury bonds higher and credit spreads wider. Total returns in corporate bonds this month are positive on an absolute basis, but excess returns are slightly negative. It has not been a very big move in credit, to be sure. While equities are down about 3%, broadly speaking, credit spreads are just 5 basis points wider. Some sectors, like banks and mining, have seen a little more volatility, but it’s been a modest move so far.

The spread volatility did keep a lid on new issue this week – the market saw just $13 billion in supply, heavily skewed towards the banks. Given the weak tone to the market, deals actually performed reasonably well, and look like they are generally trading a basis points or two tighter – though not without some noise. We expect that the calendar will pick up a little bit next week, as more companies get through earnings season. But if we see further volatility coming from emerging markets, all bets are off. Many high quality issuers were active in tapping the markets in 2013, so there is not a lot of pent-up supply, and you could see a sharp drop in new issue if volatility continues.

To say it has been a wild start to the New Year might be an overstatement. Let’s just hope they aren’t dragging us away before its over…