“The temptation to quit will be greatest just before you are about to succeed.” Chinese Proverb

“Many shall be restored that now are fallen and many shall fall that are now in honour”  Horace


Over the month of April the value of the Kelpie portfolio fell by 4.4% relative to the FTSE All-Share which was down 0.7%. The portfolio was damaged by large declines in major holdings Energold, Yukon Nevada, Gigaset De, IDT Corp, Genie Energy, Sandstorm Metals & Energy and SanDisk. It was a month where my idiosyncratic portfolio just looked idiotic.I sense a strong contrast between operational performance and share price performance; Gigaset, Energold and Aberdeen all posted good results and their share prices declined from what I already consider undervalued levels. The only bright spot was Aware Inc which was mentioned in a previous monthly for having valuable IP assets – these were sold for a sum roughly equivalent to the market cap causing a 60% rise in the share price on one day.

The biggest change in the portfolio positioning for the month was probably an increase in gross exposure via adding some long positions and increasing short exposure to offset that market risk. The reason for this is the loosening in what have been pretty high correlations between all stocks and also the sharp decline in investor sentiment as shown below. My personal view on this is that a 4% peak to trough decline in the S&P causing this much damage to sentiment demonstrates a dangerously skittish and myopic market with particularly weak and flighty investors. This makes me think the internal dynamics of the market are not sufficiently robust. However, this much pessimism usually presents potential opportunity.

In what were much more turbulent markets in April it was easy to become rattled and start to worry about holdings as their value fluctuated substantially on a daily basis.  I went through a piece of quick and dirty analysis where I examined the financial position of some of my holdings by looking how much of their current value sits in readily deployable liquid assets net of liabilities. This back of the envelope, look through analysis gives me comfort that many of my holdings have the flexibility and cash on hand to use weakness to buy back stock or to make strategic acquisitions to expand their footprint.

In general, the calculation I used was (Cash & Short Term Investments – Total Liabilities)/ Market Capitalization as of 10th April.

Some of the stocks I had to make adjustments for things like restricted cash etc but this table is not exhaustive, merely instructive and re-assuring.

Unfortunately, judging whether the market is going to go up or down on even a 12 month horizon is exceptionally difficult. As you extend that time horizon out however it becomes, somewhat counter-intuitively, easier to determine the general direction. Returns are a function of only 3 things, starting yield, growth in dividend and a change in the valuation or multiple afforded to the earnings.

From this very simple model we can sense check the predictions of the bulls who proclaim valuations are at 20 year lows and destined to perform well from here. Many market participants are currently predicting 10% per annum type returns going forward we can work backwards and see what assumptions are “baked in” to that enticing claim.

The current yield on the S&P 500 is just below 2% so we know that 8% per annum must come from dividend growth and a change in the multiple. Now if we ignore that the Shiller P/E and Q Ratio suggest 40% overvaluation and just use a fairly generous 15x multiple on current earnings of 88 we get to 1320 on the S&P 500 which is 5% below current levels. So as far as I’m concerned the best we could hope from the valuation factor is that it’s gravity like pull of mean reversion will not detract from returns.

So that means the 8% should come from the income growth element of returns but this seems optimistic relative to the long run real growth of just 1%.

Further context would consider that S&P 500 earnings are at all time highs and therefore might moderate for a while, corporate profit margins are also at extremely elevated levels and corporate profits/GDP are at levels not seen since the depression suggesting long term unsustainable inequality.


A Q2 Stall for the 3rd Year in a Row?

Multinational profits have benefited since 2009 from a potent cocktail of emerging market growth, global labour and tax arbitrage, sustained government deficit spending.  Many of these tailwinds have slowed considerably and we are leaving the sweetspot of 2012.


Analyst estimates have been moderating for a while but they have further to go, in the UK for example the consensus currently expects a rise of just 0.9% in non-financial earnings for 2012 relative to 7.9% in the US.


In 2013, US EPS growth is forecast at 12.7% relative to the UK at “just” 9%. These numbers suggest to me that expectations have further to fall in the US and my increase in short exposure there reflects that.

Analysts are obviously expecting a massive growth pick up into the latter half of the year.  The stockmarket is pricing in 4% GDP growth and I think we’ll be lucky to avoid a global recession. Now that is a variant perception. It seems unlikely to me that the P/E multiple can expand from already somewhat elevated levels at a time when analyst estimates will be coming down and growth might disappoint. Who is really going to shoot the lights out this quarter with great growth rates apart from maybe Apple (which is down 10% from its recent peak)?


Policy Driven Markets

A recent McKinsey Global Institute report reviewed 36 examples of balance sheet recessions since 1900. The standard response in about 50% of cases was a mix of belt-tightening, currency depreciation, modest inflation and export led growth based on that devalued currency. Whilst this option may be open to an individual nation it is not available to the developed world as a whole; not all currencies can devalue simultaneously and who drives the export led growth?

In the remainder of balance sheet recessions the resolution was by either high inflation or default. Defaults tended to occur in countries that borrowed in foreign currencies and high inflation in those countries which had the ability to create their own currency.

“I have absolutely no doubt that when the time comes for us to reduce the size of the balance sheet that we’ll find that a whole lot easier than we did when expanding it.” Mervyn King, Governor of the Bank of England

“One hundred percent.”  Ben Bernanke, Chairman of the Federal Reserve in response to a question asking what degree of confidence he had in his ability to control inflation.

Q4 2011 marked a clear shift in policy emphasis towards the high inflation option. As I stated in last month’s factsheet central bankers have chosen their path. The Bank of Japan, the European Central Bank and the SNB are coming under increasing political pressure from beleaguered politicians and embattled electorates to “do something”. If we have another growth scare they could move further towards promoting growth and protecting the banking. Markets have proven to be extremely reactionary and policy driven over the last few years. There doesn’t seem to be any major intervention on the cards for the next 3 months so where do the markets go?


A short in the Aussie Dollar against the US Dollar represents one of the largest positions in my portfolio at around 18%. The rationale was explained here https://kelpie-capital.com/2012/01/18/whats-going-down-down-under-the-case-for-shorting-australian-dollars/

As demonstrated below there is an obvious relationship between China Power Output and Chinese GDP growth. What is perhaps less obvious but more interesting is the relationship between Chinese power output and AUD/USD. In Jan 2012 Chinese electricity generation was down 7.5% year over year which seems pretty significant to me even allowing for the Chinese New Year.


The Most Incredible Chart of the Last 5 Years

Anyone who knows me has been sent this chart over the last few years and this is the most recent update I could find. What is absolutely amazing is not only how unprecedented the 2007 recession is but also how recessions since 1981 have been getting consecutively worse.

This would possibly vindicate my long held belief that “the jobs aren’t coming back”, the problems are structural not cyclical, the blue collar industries and lower middle class jobs of the US and Europe are gone, outsourced and automated. New industries (Shale Drilling, Healthcare, IT?) will eventually replenish most these jobs but this may take a decade for re-training and re-orientation. In places like the Euro-Zone we just don’t have that much time.


Positions Added

British Sky Broadcasting

The Weir Group

Astra Zeneca

SanDisk Corp

Positions Increased

Gigaset De

Aware Inc

British Empire Investment Trust

Berkshire Hathaway


Positions Decreased

Physical Gold ETF


Positions Sold

Investors Title Insurance Company