This is going to be a quick Fun Fund investment journal update to document my thoughts (and actions), so that I can hopefully reflect and improve over time (and, perhaps more likely, for our mutual future amusement).
I sold some stocks in my Fun Fund account last Friday, as a matter of portfolio management. If I am totally honest, however, I am also expressing a view about the overall market. The timing of “trimming” these positions was influenced by my view of the current risks and rewards on offer in the equity market.
What I Sold
On April 17, I sold half of my positions in ConAgra (CAG) and Natura & Co. (NTCO). ConAgra has been really performing well lately (or at least outperforming the trash in my Fun Fund/IRA) and had grown to almost 50% of the portfolio.
The investment was also pretty large at cost, when I put it on. This was before I decided to track this account on the blog. I was planning to continue making contributions to the account (I’m not planning to make any new contributions to the account now that I’m tracking it, so I don’t have any risk of making some “Beardstown Ladies” type performance calculation errors…lawyers and math, you know).
Why I sold it
I still like CAG, but: a) it was getting too large as a portion of the portfolio; b) it is pretty highly levered (5x net debt to EBIDTA) and even though it is crushing it right now, that gives me some pause in this environment (for example, what if supply chain issues knocked their production down/out for a bit? It could get dicey fast); c) I am planning to implement some rules for this account and the CAG position was too large at inception for the new rules; d) there are other things I like better, especially if we see mid March prices again; and e) I want to raise some cash because I don’t think current valuations reflect the probability that that the Great Cessation is not over.
I sold down the NTCO for some of the same reasons. It is not nearly as levered or concentrated after the merger, however, I am not sure how the covid-19 crisis will impact their businesses. They have some beauty retail stores (such as the Body shop and the higher-end AESOP). They also have most of their exposure in C2C, “social selling” of skin care and color cosmetics. I am concerned about how this virus will impact most of their emerging markets. I don’t want to bet on the Brazilian populist leader to handle this well (though, perhaps better than the one in the U.S.). I also find it a pain in the ass to get information about the Brazilian company, being a retail investor (though I did like their annual report/presentation). The position also predates the start of the Fun Fund thing and so I didn’t run it through the filters/rules I am going to try for this account. That is another reason I wanted to trim it (and sort of “start fresh”). The NTCO position was about a 12% position last Friday and I sold half.
Markets Underreact, creating Trend and Momentum and enabling my Macro Tripping
Other reasons are underlying both of these moves. “Macro tripping,” market speculation is not really what I want to be engaging in, but I just do not believe that the markets are reflecting the probably economic impacts of covid-19. I keep hearing pundits in the financial media questioning the market behavior given the Great Cessation. “Does this make any sense?” Plenty of people have grown more confident in the verdict of the market as the price rebound has, of course, driven the narrative.
I do not find the idea that the market might be underreacting to change/news all that surprising to be honest. I believe that the market as a whole suffers from many of the behavioral and other systematic biases that impact human market participants. I believe the market anchors on recent data, including price and is slow to incorporate new information. I think their are barriers to full “arbitrage” of new information by participants, even if they were perfectly rational. For example, many have mandates to hold certain assets (tons of equity funds have to be 100% invested and if they get systematic contributions from a pension or other investor they must plow into stocks).
These beliefs are partially founded on many academic papers and other articles hypothesizing that these biases/market structural issues could explain some of the “anomalies” that academics and practitioners have observed in markets. For example, in a recent piece on the AlphaArchitect blog, Larry Swedroe writes about trend following, summarizing some recent research.
[Trend following in this context is basically attempting to capitalize on the persistence of price movements or “time momentum.” So, you might sell an asset (like U.S. stocks) if the 1 year return is negative. By following the trend, you are basically betting that the recent price momentum will tell you something about the likely future returns over the short-term.]
Since trend has been shown to exist/persist in historical data for pretty much every asset through probably thousands of studies, one might expect it to evaporate. When everyone knows about it/exploits it, the effect should disappear.
Yet, Swedroe (and other academics) note that trend has continued to persist. Some of the potential explanations for why trend exists/has persisted to date are the ones I set forth above (e.g., that people “anchor” on recent data, or the “endowment” effect of valuing what you own more than what you could swap into, or loss aversions, etc…).
In addition, my own sense and observation of markets indicates that underreaction has been the usual course in past recessions/bear markets. It seems to be hard for humans (or many of the algorithms they write) to diverge from extrapolating recent economic (and price) data. This is certainly my recollection of how the GFC played out. The Lehman Bros collapse was on September 12, 2008. The S&P 500 didn’t bottom until March, 2009 (and the Lehman collapse was hardly the first shot across the bow).
If you’re interested in trend following or the academic study thereof, go over and nose around the Alpha Architect site (AQR and MebFaber have a bunch of good stuff as well). For purposes of this article, I just wanted note that all of these explanations for why it usually takes longer for a sell-off to really get going/fully reflect changing economic realities could again be working on this covid-19 bear market.
So it seems the base case would be to bet on slower, gradual realization of the economic and other changes that are wrought by the covid-19 pandemic. That, combined with valuations I still consider to be rich (~26.50x U.S. CAPE), led me to look for things to sell.
To be honest, I also decided to be really conservative when I saw that the President of the United States signed a stock chart that he sent to Lou Dobbs after an early covid presser which led to a market rally. It did not inspire confidence that his will be handled well by the U.S. government (to be apolitical, it seems to me that DeBlasio in NYC has also done a horrific job).
I also have noticed that many of the investors I respect do no seem to be finding the risk-reward of the U.S. stock market to be very attractive currently. Munger was recently quoted in the WSJ expressing very cautious sentiments Below, Carl Icahn also talks a little bit about his cautious view of the markets (though it should be noted that’s generally not how he has made his money):
All that being said, I feel I have adequately justified having almost 33% of the account in cash….to….myself. In the words of David Tepper (a few years back), “Just don’t be too freaking long here, ok?” Thanks for helping me work through that. You are such great listeners.
Building my Wells Confirmation Bias
As stated in prior articles, I own WFC in this account. It is just less than a 10% position. I have also been buying in small amounts (post covid, below TBV) in some other accounts, like my HSA. Chris Davis of Davis Funds recently appeared on Morningstar’s Long View Podcast and discussed Wells along with some other things.
In my book, Davis has serious street cred, especially when it comes to financials. He was quite enthusiastic about Wells (and Charlie Scharf) in this interview.
I also thought it was an unusually good interview of Davis because they got him to talk about some ideas that were outside the “financials” sector. Interestingly, he talked about the UTX spin-offs: OTIS and CARR (and the remaining RTX business that has been merged with Raytheon). I have been watching/reading about Carrier and Otis. Terry Smith and Fundsmith has talked about the elevator business many times if you want a quick primer on the industry. I have long noted that Lennox ($LII) always shows up on list of business with high ROE/ROICS. The industry seems good for some reason (seems like maybe an oligopoly and good parts/services, dealer network returns).
Steve Eisman of the Big Short fame, was recently on CNBC and talked about how he likes the big U.S. banks (Eisman also continues to be short Canadian ones…he’s been on that short for a while. I would like to own Canadian banks at a price/after a real good cleansing of the sin and folly in Canadian RE). I think Eisman is a good voice to listen to on financials (especially when we are talking about credit quality/reserves).
I do like to be on the same side of this WFC investment/thesis with these two investors. Just to curb the enthusiasm a bit, if the new batch of Forms 13-F in May reveal that Berkshire has continued to sell WFC, I will be “shook.” You can’t place too much weight in the opinions of others, but he is also probably the greatest bank investor alive. Also, there is clearly some risk in being in 10x levered financials when we are looking at ~25% unemployment in the U.S., which could last for god knows how long.
For better or worse, I will not be permitted to sell WFC in the Fun Fund no matter what BRK does. This is because I am implementing some “rules” governing how I am managing the account. Some of the rules are designed to make me be very careful about what I buy (and to sit tight after I buy it). I am going to write about those in my next Fun Fund post (I need to hurry and get them published to counter the constant temptation to violate them).
So, that it for this update. I am market timing and investing in levered financials in the midst of a pandemic. What could go wrong? Oh well, it is only money. I hope you are you families stay safe and come through this crisis stronger than before. Thanks for reading!