Monthly Archives: April 2010

This Is Who I Am

Popeye the Sailor

Popeye the Sailor

A few years back, I would occasionally be asked to appear on a cable news show to discuss my views on the Asian markets.  Asian specialists were somewhat rare in New York City at the time, and demand for my point of view, especially following dramatic events (earthquakes, currency crises, etc.) ran high.  Once I remember speaking with the young woman who was applying make-up to the guests of the show.  As I surveyed her array of colored powders, brushes, sponges and other paraphernalia, I was interested in how she got this job.  Somewhere during the course of the explanation, she said something memorable, “This is what I do; it’s not who I am.”

I have considered this statement over the years and I think it has profound implications.  First, not everyone “is the job.”  There are a lot people who view their jobs just as something to do to earn money, keep out of trouble, pass the time, etc.  These individuals no doubt maximize their personal utility by doing other things, such as hobbies, forms of entertainment, spending time with friends and family, and so forth.  The stereotypical actor/waiter is a classic example of this.  The person is an actor, but is working as a waiter.

Second, does a person who “is the job” make a better employee?  I suspect that most managers would say “yes.”  Someone who lives (and loves) to work at the job of his/her choice must be a pleasure to have on board.  That level of commitment is the essence behind the “think like an owner” concept.  Still, I wonder if someone that committed can really find the balance, which seems so important in life.  I have seen many sad endings to people who could only find satisfaction in the workplace.

This brings us back to me (it’s my blog, after all…).  One of the nice things about growing older is the feeling of increased self awareness.  I think I know myself much better now than I did 20 years ago.  And as it pertains to this blog and my career, I know that I am a value investor.  I may have been this way my whole life, but working on Wall Street and investing in the stock market has solidified this understanding.  I may lack the skills of Warren Buffett, John Neff, or any of my investment heroes, but I know that deep down we are all cut from the same bolt of cloth.

Throughout my career I have filled many positions, have had many jobs, but each time I approached the tasks at hand as a value investor.  I love buying or recommending stocks at a big discount to their fair value.  It seems so basic and simple to me, but most people I speak to struggle with the concept.  We love to buy “things” on sale – clothes, cars, computers, etc.  But when it comes to stocks, people generally want to buy the  ones that have gone up the most – those that are expensive [by “expensive” I mean highly valued, not those with a high dollar value – a stock trading at $100 is not more “expensive” than one trading at $20 to the value investor].  This tendency makes the concept of “stocks on sale” hard to grasp by the average person.  Many people spend a great deal of time and effort trying to fit in.  The value investor does the exact opposite.  We constantly search for the less-traveled path.

Sometimes it’s a lonely exercise, but in my experience, it’s well worth the effort.  Recently, a junior colleague of mine, obviously puzzled by my lack of apparent enthusiasm for a happy development in my family asked, “Goodson, what do you get excited about?”  With only a split second of thought I answered, “Generating alpha.”  That is, I enjoy beating the market.  Always have.  Hope I always will. That is who I am.

Volcanoes and SEC Notices

volcano

Eyjafjallajökull

Anyone who flew to Europe last week for a short trip was no doubt surprised that a volcano in Iceland would cause their return flight to be cancelled.  After all, the volcano had been dormant since 1823, and besides, when was the last time a volcano interrupted air travel?  Mount St. Helens (1980)?  Mount Pinatubo (1991)?  Granted, “Eyjafjallajökull” doesn’t exactly roll off the tongue, but that mighty mountain’s effect will be remembered by a lot of folks for a long time.

This surprise eruption underscores the uncertainty inherent in our world.  Unexpected things sometimes happen, and often their impact can be widespread and may persist for longer than seems reasonable.  I suspect we will soon be hearing about how this volcano‘s output will be affecting the weather, carbon gases in the atmosphere, global ocean patterns, and so forth for months or even years to come.  One thing can make a big difference.

For the capital markets, the Security Exchange Commission’s (SEC) charging of Goldman Sachs with civil fraud related to mortgage securities is something akin to a volcanic explosion.  The stock market’s decline on Friday seems wholly linked to this one event.  Above all else, the markets fear uncertainty.  This action by the SEC has raised fear in the marketplace.

Not being a lawyer or an expert on SEC regulations, I will not comment on the merits of these charges.  I will note that Goldman Sachs and the other big banks tend to have very good legal teams and every single security they sell and every single research report they publish has been vetted, examined and reviewed by these top-notch legal groups.  So, I would be somewhat surprised if this case has impact as long and deep as the market may fear right now.  Time will tell.

On Thursday I was discussing the market with a junior colleague, who suggested one might want to “go long volatility.”  He noted that the markets’ volatility (as measured by the VIX) was very low and seemed to be cheap, in his opinion.  Buying the VIX seemed like a good trade, in his view.  I, in my role as the know-it-all senior investment guy, pooh-poohed his idea and said something to the effect of “I can’t imagine anything de-railing this recovery or this bull market.”  Well, the very next day his VIX trade (had I not talked him out of it) would have made him 15.5% — not a bad for one day!

I still think that this single event is unlikely to de-rail the recovery; it has nothing to do with corporate earnings, interest rates or cash on the sidelines, but it has raised the risk profile of the markets a bit.  Yet, I learned (or more precisely re-learned) a couple of important lessons from this experience.  First, I don’t know everything.  Yes, that may be obvious to the rest of the entire universe, but after a good run in the market, anyone can get sucked into the illusion of market mastery.  As I often say, humility is a necessary trait for anyone who wants long-term success in the market.  I need to remember it, not just say it.

Second, respect all opinions and sources of information.  This is another fundamental truth of investing which I ignored last week.  My colleague, despite his youth, is very sharp and often sees things that I miss.  So I know this rule (generally), but sometimes the weight of my experience gets in the way of seeing this.  I am not suggesting that all opinions are valid or even useful, but dismissing any because you think you know better is a recipe for missed opportunities.  Balancing one’s own views with the myriad of data out there is ultimately one of the big challenges of being a professional investor.  The market usually rewards independent, contrarian thought, and my colleague’s opinion was a classic example of this.

I continue to think that we have entered a new bull market which will take stock prices much higher from where we are right now.  In bull markets, corrections of up to 10% are normal and actually provide investors the opportunity to test and re-test their ideas and opinions about the market.  I don’t know if this SEC-Goldman Sachs thing will lead to a full-blown correction or not, but I think I would rather be buying stocks now than selling them.

Corn, Beans and Squash

Corn, Beans, and Squash

The northern part of the Yucatán peninsula is a very interesting place.  I was surprised to find out that the Mayan language is still spoken by over 6 million people in the area.  I would have guessed it would have mostly died out given that the Mayan civilization peaked sometime before 900 AD.  To my ear, it is a very pleasing-sounding language and one that has a very long history.  Geologically speaking, the northern Yucatán is monolithic, that is made of “one rock.” If you like limestone, you will love the place, because that’s all you get there.  The entire area is one huge slab of limestone gently sloping downward into the sea.  No granite, no sandstone, no gneiss, no metal ores – only limestone.

A couple of other notable features follow this unusual bedrock.  First, there are no above ground rivers in the area.  The only water available is underground.  Second, there is almost no soil; our guides suggested that only a few inches of soil is available in most areas.  To think that the Mayans built one of the most sophisticated civilizations in the world to that time, much of it on this harsh slab of rock, boggles the mind.

While at the seacoast ruins of Tulum we learned about a clever adaptation Mayan famers implemented in the shallow soil there.  They would plant in the same patch of land maize (corn), beans and squash.  The corn stalks would provide a natural trellis upon which the bean plants could grow and flourish while the squash would cover the remaining bit of ground with their leaves and fruit.  Thus they could grow and harvest three different and complimentary crops in the same area – all three would grow and thrive in that thin soil.

For some reason, this discussion got me thinking about equity investing. As I pondered the question why three crops in one plot of ground were better than just one, I saw the parallel to an equity portfolio – three stocks are better than one.  Let me explain.  The best performing stock in the Down Jones Industrial Average is Boeing (BA), which is up about 30% so far this year.  Anyone who had Boeing and only Boeing in their portfolio this year would be very happy.  But would that person realize that a portfolio which contains only Boeing represents the riskiest portfolio possible?  Risky?  “Poppycock!” you might say, “there’s no risk, the stock is UP!”

Alas, here is one of the great misunderstandings in the field of investing – risk is not the same as losing money.  Risk is a measure of volatility; losing money is what happens when prices go down.  One can have a diversified portfolio and still lose money.  Yet, the probability of seeing wide fluctuations in returns rises the fewer stocks one has in the portfolio.

The key here is what the pros call “systemic risk” and “non-systemic risk.”  Systemic risk is the risk we all share by the fact that we own stocks.  The market’s movements and volatility impacts our portfolio to a sizable amount. There’s not much we can do to lessen this kind of risk.  Non-systemic risk comes from the stocks we own in our portfolio.  Each stock has a unique risk profile that will affect our portfolio based on its own volatility.  Mathematically, a single stock portfolio has the maximum amount of non-systemic risk (regardless of the return in any holding period).  As if by magic, simply adding another stock (assuming its risk profile is not identical to the first one) will reduce the portfolio’s overall risk profile.  Adding another one will help some more.  Studies have shown that owning about 30 stocks is the optimal way to reduce non-systemic risk to something close to zero.

Perhaps the ancient Mayans would have been astute investors – they seemed to be pretty good at everything else.  I suspect they would have understood the merits of portfolio diversification and invested accordingly…

What Else Do We Need?

Last Friday’s employment report contained a very happy surprise – 162,000 jobs were created in the merry month of March.  This was better than expected.  To some the fact that some of these jobs were temporary jobs related to the Census, was enough to take some bloom off the rose, but from my perspective, this is great news.  Almost no one was expecting job growth this early in the cycle.

In a conference I attended last month, a famous portfolio manager suggested that the US economy could be posting 200k per month job growth by the second quarter of this year.  This bold forecast was met with great skepticism from the audience, which was mostly comprised of professional investors and other industry practitioners.  I suspect that everyone may need to brush up (that is, revise upward) their forecasts for job growth in 2010.

Following this employment number, I find myself asking, “What else?”  What else do we need to convince those still on the sidelines, hugging to their zero-percent return cash bundles, that the economic recovery is real, that the new equity bull market is entrenched and sustainable, and that the widely-feared “other shoe” isn’t coming?  Corporate earnings growth and cash generation is great.  Company balance sheets are very strong.  Demand from the emerging markets is helping many US companies generate nice profits.  Monetary and fiscal policies are still quite simulative.  Inflation is benign.  The widely-expected collapse of the US dollar hasn’t happened.  Even housing is looking at turning around.  What else do we need?