Let the Show Begin

Waiting for my youngest son (above) to participate in his first nativity play yesterday afternoon, I tried not to look at my Bloomberg app. Or think of the roller-coaster the financial markets could embark on if we were to get a surprise from the U.S. Federal Reserve later in the day.

When my son arrived in the gym hall, I could see his excitement with dad in the front row. I arrived early just to make sure I’d get a good seat (and parking). As the older kids and teachers started their introductions, etc. I could see my son’s excitement start to wane as he sat with his classmates waiting for the show to begin.

Bump up not lift-off

Just like the millions of professional investors who literally were sitting on their hands for most the day waiting for Janet Yellen and the Federal Open Market committee at the same time. Providing us their interest rate decision so we can move on with our day. Which makes me wonder, why they don’t hold the conference first thing in the morning and help reduce the anxiety on trading floors worldwide!? One of many humble suggestions I can give to central bankers if I were to get in a room with them.

So now we finally have the much-anticipated interest rate hike in the U.S. It’s not a major move. However it’s the potential of it becoming the beginning of the end of low-interest rate environment that has some economists and “fed watchers” all excited.

But what does it mean for most investors and business managers? Based on my crystal ball and the Economist in me (yes, I do have a degree in Economics), I don’t think we’re going to be out of the low-interest rate environment anytime soon.  The U.S. economy is not healthy enough to be able to sustain series of interest rate rises based on the data I’ve seen. Sure the U.S. jobless rate is the lowest it’s bee in seven years. We’ve seen relatively good performance out of the U.S. economy over the past few years. But the U.S. is not immune to the global economic slowdown and will have to tread very carefully to avoid falling into a recession.

But it doesn’t matter what I or you think about interest rates. It is what it is. It will be what it will be. Many investors and business managers spend too much time trying to figure out what will happen. And often times what ends up happening is what we least expected. We simply need to understand the possible scenarios, what impact these scenarios will have on our assets or earnings, and take steps to mitigate the impact of these potential scenarios. Or preferably how to benefit and improve the financial position under these various scenarios. Difficult but not impossible.

What it means to you?

As an equity investor I don’t see any significant impact from the interest rate hike on my portfolio. Since most of my companies have low debt and I’m defensively positioned. However if interest rates do start to increase steadily over the next year, the already fully valued equity markets in the U.S. could see major price declines.

For the struggling pensioners and savers relying on interest income, it’s too early to start rejoicing. The quarter basis point increase or 0.25% is nothing to cheer about just yet. Over the past almost decade savers have been punished with huge transfer of wealth from savers to debtors by means of a low-interest rate. They will not see improvement in their miserable investment income anytime soon.

Business managers need to become more prudent with their accounts receivable to ensure they get paid timely and proactively monitor their clients financial positions. Bad debt is often a silent killer on balance sheets.

Key is to seriously consider what are the implications of a series of interest rate hikes next year. That would significantly increase the cost of borrowing despite interest rates still being near historical lows.

As a business manager you need to be conscious of potential change in interest rate environment and the economic instability or recession it could trigger. Be extremely careful taking on debt and on the other hand if requiring financing to do it sooner rather than later.

An interesting fact is that credit markets have been tightening well before yesterday’s interest rate increase. Goldman Sachs tracks a financial conditions index which measures and incorporate factors such as stock prices, credit spreads, interest rates, and the exchange rates to determine the impact of the interest rate movements.

According to Goldman Sachs estimate, it says that every 1% rise in the federal funds rate shows up as 1.5%  increase in the index.  The index sits at the highest level it’s been in five years since September of this year. Borrowing costs for business could increase dramatically over the next few years if interest rates continue to rise.

Get ready for a quite a show

But at least the December interest rate hike is done and dusted. Investors are in for quite a show as market participants (primarily economists) will continue their obsessive discussions of how much and when interest rates will rise next year.

Smart equity investors will ignore them and carefully look at valuations and rotate out of momentum and high-beta shares in favour of value and distressed equity. Speaking of distressed equity, energy shares which have taken brunt of the tax-loss selling may finally stabilize. Successful investing over the long-term is always about quality assets and cash flow.

I don’t know if the Santa Claus rally will transpire over next few weeks. But either way Mr. Market can now get the show on the road.

Happy holidays to everyone!

Lunch with Warren Buffett

lunch with warren buffett

Every year the legendary investor Warren Buffett gives anyone (with a few dollars to spare) an opportunity to have lunch with him. All proceeds going to the Glide Foundation providing meals for the needy. This year the auction will begins today on June 2nd, 2013 for five days.

Before you get excited, I’d like to remind you the previous year’s winning bid was $3.4 million! Unfortunately well above my charitable contribution budget for the year.

However dozens of books have been written about Warren’s investment philosophy, style and strategy. Hundreds more in articles and resources can be found in the public domain and on the Internet.

Interestingly early this year, fund manager Mohnish Pabrai shared some of the insights  on the Motley Fool site from his 2007 bargain $650,100 lunch with Warren and his partner Charlie Munger.

Key lessons Mohnish took away from the lunch were:

  1. Be patient.
  2. Don’t use leverage or borrow to invest.
  3. Look at what other successful investors are doing.
  4. Invest in “cannibals”, companies buying back their own shares.
  5. Carefully study “spinoff” companies.

That’s it! If you’d like to learn more about value investing, I’d be happy to give you more tips over lunch anytime. And no it won’t cost you a little fortune.

Happy bidding: eBay Auction Link for lunch with Warren Buffett


Gordon Gekko Got One Thing Right

Greed is not good. It’s what leads investors to disastrous losses.

But Gordon Gekko, the fictional character from the infamous movie Wall Street (1987) got one thing right: “Ever wonder why fund managers can’t beat the S&P 500? ‘Cause they’re sheep, and sheep get slaughtered.”

Golden Lesson Yesterday

Most investors (and their fund managers) are lemmings. Or as Gekko would say sheep that simply follow the “herd” to the slaughterhouse. Therefore up to 80% of them fail to outperform their own benchmarks. Why they behave in this manner is discussion for another time.

But a classic example of this was yesterday’s sell-off in gold prices. The gold market experienced its worst loss since 1983. Why? Apparently over poor Chinese economic data which signals a slowing global economy.

Based on our analysis of the gold price collapse, it had nothing to do with the Chinese data. It was simply an excuse to sell-off gold which we warned the previous week with a NEGATIVE rating alerted our clients to on April 5th http://www.sialpha.com/gold-prices-at-key-support-level/

Our quantitative investment systems have been alerting us to poor price action and money flow over the past month as monitored by our analysis of the Gold ETF (GLD) which has lost over 13% in the past month.

On Friday morning our systems became extremely negative on Gold in the immediate term and we exited all our commodity large cap and ETF positions. Alerting our clients and posting on twitter @BuyandManage at 10:54 am EST:

“Time for caution. #Gold $GLD prices down 3.57% breaking through key support at the $1525/oz on route to $1350″

After our twitter post on Friday afternoon a massive $20 billion sell order hit the gold market. I can assure you it wasn’t us. But likely a hedge fund or algorithm that came to the same conclusion as we did in the morning.

That large sell order foreshadowed the panic selling on Monday morning. I’m sure some frantic calls were made in hedge fund circles as money managers tried to figure out who was selling and why?

And you can imagine John Paulson’s investor relations team must be fielding higher than normal call volumes as his funds reportedly lost over a billion dollars on their gold positions since Friday.

What to do now?

Well I can’t tell you what to do. But if your financial adviser or money manager is selling gold now or failed to reposition your portfolio against an obviously overheated market, you likely have a “sheep” working for you.

But I will tell you what we’re doing on our own investment portfolio. We actually share our performance results every month with our research clients and for anyone that wishes to follow us. View our monthly results here.

Our SiAlpha portfolio yesterday was actually up almost 1% as the markets were down on average 2%. Now how is it possible for us to completely avoid losses when the broad markets are sharply lower?

How We Make Money?

Well first, we did not go short the market, gold or any individual stock. Going short would enable us to profit from a decline in the value of that asset. We’re not speculators. We are investors. We did however have some long/short positions on same stock to hedge our current positions and avoid losses.

Neither did we buy heavily into stocks that were sold off yesterday. Although we couldn’t avoid extremely oversold companies and did take small positions in commodity producers such as Barrick Gold (ABX) and Suncor Energy (SU) which fell by 10% and 5% yesterday.

The reason we are able to achieve a positive rate of return even when the markets are falling is the fact that we construct a portfolio of 70-100 companies with low correlation. These companies represent either very good value or very strong positive price momentum with a high probability of asymmetric returns.

Simply we invest only in businesses and assets (such as commodities) that have a high probability of large profits relative to their potential loss. So we are looking at earning a profit of 30% on a potential risk of 10%.

This is low risk-to-reward investing, cornerstone of our investment selection and risk management process. It has enabled us to deliver an outstanding 46%+ compounded annual return on our funds since inception. A hundred thousand investment would have grown to over four hundred thousand in less than four years!

The process is managed by SiAlpha, our proprietary Quantitative Value and Momentum Investment System. Learn more at http://www.SiAlpha.com