Believe In America (Part IV)

March 26, 2017 6:52 PM


Almost 5 months ago, Trump won the presidential race. At the time, I said Trump would herald dramatic change in how the government worked and served the American people. Along the way, regulations and taxes would be reduced and business would boom. Part of what made Trump so unique was that he wasn’t part of the Washington establishment. He couldn’t be controlled by special interests and he didn’t care about what people thought of him. Instead, he was a rich jerk who intended to bully and antagonize the forces that have stalled economic growth for the past few decades. Trump had a goal and he intended to end his presidency with dramatic economic growth—how he got there may be sloppy and would likely upset a lot of apple carts, but he’d get there.

I still believe these things. Unfortunately, it seems that Trump is running up against the ramparts of the Washington machine. The forces of obstruction intend to defend their hard won perks. Lobbyists in the Republican and Democratic camp are working together to ensure that Trump remains impotent. I guess that this shouldn’t be unexpected—Trump is part of a new party that stands for America instead of special interests.

I am confident that he will win over them or at the very least, steamroll a lot of people who are for standing in his way. However, this heralds a new stage of Trump’s rise to ascendancy and I suspect that it will lead to a level of political infighting and uncertainty that hasn’t been seen in a long time. The dreams of rapid economic growth may have to be deferred, as Trump must first fight his own party for supremacy. Only then can he tackle his agenda.

unity

We’ve had a yuuuuge rally in equity markets based on a belief in rapid change. The talk was that Obamacare would be repealed on day 1 and tax reform would be day 2. Day 3 would be a victory lap. No one is positioned for quagmire and the dysfunctional process of lawmaking.  The market is very much ahead of itself if Trump cannot implement his reform platform rapidly. A few weeks don’t matter, a few quarters do.

Even worse, many parts of the economy are struggling—with retail and dining along with everything tied to that supply chain front and center in my mind. Remember, a whole lot of real estate is tied to these sectors and cap rates are expanding. Then there’s oil, which seems to be finding an equilibrium price at a level where most shale producers are not cash flow positive, but with sufficient cash to keep spending for many years into the future. This may weigh on the whole global oil sector. Is another credit crack-up coming at a time when rates are rising?

I don’t short equities, but I cannot think of a more pregnant time to do so. I certainly wouldn’t want any long positions here. Over the past few weeks, I’ve continued to sell shares. I have almost no longs and I still feel over-exposed. Is a yuuuuge re-adjustment to the downside imminent? Trump will prevail, but I think there will be a time to play that theme from potentially much lower levels. I'm now out of the bullish camp for the first time since Trump won. It's been an awesome ride.

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Recent Interview

January 23, 2017 8:54 PM


I was recently interviewed by Chris Lowe at Bonner & Partners about my views on the market. Please click here to read it.

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Believe In America (Part III) Avoid Lobbyist Stocks

January 13, 2017 1:31 PM


lobbyists

With the stock market continuing to make new highs, it feels almost irresponsible for me to talk about things to buy without at least waiting for a pullback. Therefore, I think it makes sense to talk about what to sell.

One of the defining characteristics of the Trump administration will be “draining the swamp.” That means a lot of things to a lot of people, but as it relates to stocks, it means that if a company relies on subsidies, rebates, regulations and government meddling in the free market in order to succeed, you need to think very clearly about how a more honest government would impact your company. We’ve already seen how companies that are doing business directly with the US government have been warned to cut costs. Air Force One shouldn’t cost $4 billion. That’s silly. Profit margins for all companies doing business with the US Government are bound to drop. Some of this is priced in—a lot of it isn’t yet. However, many of these situations are obvious to investors already. They know that change is under foot and are watching closely. I’d like to talk about what I call “Lobbyist Stocks” and how the changes coming aren’t as obvious to investors yet. These are the stocks that need lobbying in order to succeed—or at least to earn excess profits beyond what the free market would give them. Here are a few examples;

-All of us pay taxes. At a certain level, we realize that they’re the price of civilization. In return you get roads, bridges and hospitals. While I think the system is being abused, I am willing to accept that some limited wealth should get transferred to those less fortunate. However, why should $7,500 of tax credits be allocated to a rich guy buying a $100,000 Tesla (TSLA)? Does that make sense to anyone? How does that benefit America? How would an elimination of this subsidy impact Tesla?Tesla is my favorite short—if I shorted—for many reasons. The potential elimination of this tax credit is yet another reason to believe it’s a zero. Will this rebate exist after the swamp is drained?

-I love getting packages from Amazon (AMZN), but the only reason that Amazon is competitive with Walmart (WMT) is that Amazon gets a massive government subsidy. You see, the post office makes money on delivering envelopes and those stupid advertising inserts that clog up your mailbox, but the post office loses globs on delivering packages. If the USPS priced package delivery at a level that guaranteed a break-even result, it would cost Amazon about $5 billion more. If the post office actually tried to earn a profit at it, Amazon would truly bleed money. It’s not like Amazon can turn to someone else to deliver its packages in less densely populated areas—that’s the reason that the USPS is delivering them in the first place. Is it any wonder that Bezos bought the Washington Post to be his soapbox? Is it any wonder he cozied up to the Democrats as blatantly as he did during the election? Imagine if each delivery cost $10 more—would you still order from Amazon?

-Murphy USA (MUSA) operates gas stations. You’d think that the business involves selling gasoline, soda and potato chips, but that’s not all there is to the business. In 2015, 53% of EBIT came from RINs. What the hell are RINs? Renewable Identification Numbers are funny credits the government gives you for selling fuel that is mixed with biofuels. Gas stations get them, but refiners don’t—unless they own or are partnered with gas stations. This law favors integrated refiners and blenders while penalizing non-integrated refiners. Carl Icahn has been complaining about the stupidity of this law for years and he certainly has Trump’s ear. Will RINs exist in a year? Is a normalized EBIT without RINs priced yet into MUR's share price?

drain the swamp

I can go on and on. My smart friends have told me of dozens of examples like this. I don’t short, but I don’t blame them for shorting these stocks. I am not saying that these companies did anything wrong, they simply set out to maximize their profits within a rather corrupt government system. Some of them weren't even the ones paying for the lobbyists, they just took advantage of existing lobbying efforts. I anticipate that Trump will at least partly “drain the swamp” and some of these "lobbyist stocks" will be penalized. The question is--which ones? With the market making new highs each day, my advice is to go through what you own and figure out which ones need lobbying to survive—if it needs lobbying, be weary. Fortunately, new highs are a great time to sell companies that you might not want for the long-term.

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Indexers Are Running Amok...

December 24, 2016 11:57 AM


So, this should be pretty easy to sort out. Crawford & Co has two classes of stock, A and B. The A shares pay a dividend that is 2 cents a quarter higher than the B shares. There are differences in voting rights, but as there’s a control shareholder, those are irrelevant. Therefore, a simple analysis says that the A shares ought to trade at a moderate premium to the B shares to account for the nearly 1% higher annual dividend yield. NOPE!! The B shares are in the Russell 2000 index and the B shares now trade at roughly a 35% premium to the A shares.

Now, I’m not here to pass judgement on the investment merits of Crawford and the A or B shares. I have done no analysis on the company and have no opinion on if it is a good investment or not. However, I know that the A shares are better than the B shares as you get a higher dividend and there is no logical reason for the B shares to trade at a huge premium except that the Russell 2000 index has to keep buying them as more money is allocated to the index.

Two years ago, I noted how index funds and ETFs were warping asset valuations and creating opportunities for those who were willing to seek them out. This trend has only accelerated since then and has grown from something of a curiosity in certain asset classes into a true bubble that is doomed to eventually pop. There are now hordes of overvalued assets that have no justification for their overvaluation, except that index funds have to own them. Like all bubbles, this one too will burst.

In the interim, there will be huge opportunities created by how index funds misallocate capital. As I said earlier, I know nothing about Crawford, but if I wanted to own it, I sure as hell wouldn’t be buying the B shares when compared to the A shares. Additionally, I feel pretty confident in saying that at some point in my career, the A shares will trade at a premium to the B shares—as they deserve to. At the same time, I wouldn’t be betting that this spread collapses any time soon either. Shorting indexing has been a widow-maker for many in the hedge fund industry—it’s hard to fight against fund flows. In finance, when a trend gets in motion and the marketers start pushing it (indexing and ETFs today) you can expect it to go further than is logically possible, but the hangover will be pretty epic. Along the way, there will be a lot of money made by better understanding the flaws in these indexes and front running them—much as I front-ran the marketing department back in March.

As a final note, I’d like to share a chart with you from Passport Capital showing the median total returns of markets graduating to the MSCI EM since 1994. If you can’t beat the indexers, you might as well make money off of them by getting there first.

MSCI EM

There will be more posts on this topic as it is a fertile place for opportunities.

 

Disclosure: No positions In CRD/A or CRD/B

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Believe In America (Part I)

November 17, 2016 12:16 AM


“The improbable is now possible!!!”

That is the last coherent sentence I remember a friend uttering on election night, as I finished off a flight of beers before switching to endless bottles of champagne. I then spent the better part of the next 36 hours roaming the streets of South Beach, yelling “FREEDOM!!” until my voice gave out and buying drinks for anyone who claimed to have voted for Trump. Over 2 nights and a day, I visited almost every watering hole on the beach, sprayed champagne on friends and celebrated America’s future.

I didn’t live through World War II, but I assume that victory celebration was equally epic. America has once again been saved by its citizens. Never before, or since, has something this serious been this close. We all dodged a meteorite with inches to spare. We now have a modernizer in office, controlling all three wings of the government, intent on fixing America. Only a few days ago, America’s future mostly resembled Venezuela’s. My outlook had been bleak and sour. Now we will once again be the America we have been missing out on for the past few decades (literally my entire life). The shackles will now come off and we will be allowed to flourish. Americans have become so numb to the idea that things can change for the better, that the coming prosperity will genuinely surprise people.

We’ve been mired in a no-growth economy for two decades—what happens when we hit 5% GDP growth?

We’ve been fighting “deflation”—what happens when demand comes back?

We’ve exported millions of jobs over the past two decades—what happens when there is genuine wage growth for all Americans?

Taxes have suppressed business. I cannot even fathom a 15% corporate tax rate here in America—what happens when it’s more efficient to run a business here, than offshore it?

Obamacare has destroyed jobs, strangled businesses and held America back—what happens when we’re freed of it?

Regulations have made small business too complicated to bother with—what happens when the American spirit is let loose to build?

I can go on and on. There is dramatic change coming. One of the ironies of the most recent election is that there was so little substance to the actual campaign. “She’s corrupt.” “He’s sexist.” The debates rarely got much further. What does Trump really stand for? No one is sure. I think this creates huge opportunity for those of us who can figure it out first. Sure; more infrastructure, less regulation, lower taxes, better relations with the international community, but I want companies that benefit—not bland pronouncements.

flag

As I sobered up this weekend and chatted with my smartest friends, I have set about trying to discern what will happen. There are going to be huge winners and quite a few losers in Trump’s America. If you can figure it out before it happens, fortunes can be made. Over the next few pieces, I will tell you about some of those winners and losers. I promise—no more politics.

For starters, my whole outlook as an investor has changed dramatically for the better. Before the election, all asset classes moved in unison to Central Bank printing. Now policy changes will bring back prosperity—the Central Bankers will matter less. For most of the past 6 years, I’ve owned gold, sat in cash, ventured overseas and waited for an apocalypse in order to buy bargains. Now, I want to own small American companies that are about to prosper like never before. Gold? I’ve owned it for over a decade. I’m not selling, but certainly not buying more. It’s a hedge that has become rather unnecessary as economic growth takes off. Sure, there will be some inflation, but I want to own stuff with returns on capital. I want to own stuff that is about to grow rapidly. I’m excited; I get to be an investor again and I’m in a country that suddenly has a very bright future.

Despite not being a fan of Trump, the individual, I suspect that he ends up being the best president in almost a century. For 18 months, everyone has underestimated him. They’re still underestimating what he can accomplish. Big picture, he gets it. Sometimes, it takes a jerk to solve problems. Buckle up; the next 4 years are going to be YUUUUUGGGEEEE for investors who believe in America.

 

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