Dear Investors,
I
am writing this month's letter under the presumption that even those of
you who don't pay much attention to the stock market are feeling more
perplexed than ever after the week that just ended. As a result, I've
scrapped my usual format. Instead I'm going to tell you what I expect
to happen in the market next, and what I intend to do about it. Then
I'll update you a bit more on Tarpon. Next month - more on my
recent trip to Omaha.
Before I Begin
First, I'd like to start with a request. If you're feeling
particularly anxious about anything - your investment here, the
economy, the price of tea or your Labor Day travel plans - call
me. Or email me.
Stop by the Dynamite building. Text me. Whatever is easiest.
Please remember that this is not a mutual fund. You and I...we
can talk.
Second, a simple request:
Turn off your television.
Seriously. It may seem like there are three dozen reasons to
go hide under your house right now, but there are probably only
two that might still be meaningful for your portfolio this time
next month. In the meantime, please take a deep breath, grab a
Post-it note, and scribble this down to stick on your bathroom
mirror:
"Fear and uncertainty are the friend of the long-term
investor."
Third, please realize that attempting to predict what will
happen the next few months in the stock market, let alone the
next few trading days, is something for which I have shown zero
aptitude. Nobody can do it well, actually, despite the number
of people who seem to believe otherwise. So, take my opinions
below as just that.
Finally, to those new investors in Tarpon who have been
onboard for just a little while, I'd like to say, "This is how
value investing works. There is no such thing as outperforming
the market without going against the grain, and because Tarpon
is a focused portfolio, things will jump around on us. In the
long-term, though, that's going to be a very good thing. And
all the while, we will unequivocally be in it together."
Oh, and this: "PS. When I launched Tarpon in late 2008,
some very smart people thought I'd completely lost my mind. But
things worked out well. And this is not quite that bad."
Where We Are
There is one signal in the market noise lately
that has had an outsized influence on recent market results - the credit crisis in Greece. Here's
a short column explaining Greece's woes that I wrote for
the local paper a few weeks back. And here's where things stand
now from an investor's perspective:
After the close on Friday, the market appeared to me to be either
(1) braced for a real catastrophe or (2) in yet another bout of
temporary insanity. The actions I have taken and will likely
continue to take with our money are based largely on my belief
that what we're currently seeing is that second option. The
reasons are many, but one incident that I believe underscores
that the market is not behaving very rationally is the brief, mysterious 9%
"trading glitch" drop on Thursday. In the time it takes to
microwave a Hot Pocket, a trillion dollars of wealth
effectively vanished - and no one seems to
know why. I have my
own theory, mind you, but my point is that it wasn't the
type of problem that happens in an excessively rational
enviroment. There are inefficiencies in the market right now,
and I feel it's my job to exploit them.
That said, there is often a fine line in value investing
between being opportunistic and just plain stupid. The two can be
indistinguishable for a while. While I'd like to think I know
on which side of that line I am currently standing, it's
entirely conceivable that you may not be certain for months.
Here are two character traits of mine that might be useful for
you to know as you attempt to divine the difference:
I have little fear of looking foolish if it means saving
or making money.
For instance - and my daughters will one day be mortified
I'm admitting this - I often cut my own hair. I also drive a
fifteen year old car in dire need of a muffler. Buying
unpopular stocks at seemingly inauspicious times just comes with the territory.
I believe I am more comfortable with short-term
uncertainty than the average investor.
See that "launched Tarpon in '08" bit above. This is a
reflection of the work that goes into each of our positions, as
well as an effort to avoid false precision. I also try to be
pretty rigorous in ensuring that my comfort doesn't stem from
overconfidence.
I also have several thoughts regarding that point above
regarding the risk of imminent catastrophe. One of the more
pervasive conceits of Wall Street is that only it can foresee,
understand and predict financial risk. How this belief
continues to perpetuate among anyone alive in 2008 baffles me.
Nonetheless, the recent sell-off would seem to imply one
thing - that an omniscient Wall Street does not believe the
credit crisis in Greece is going to be properly addressed.
I'm
simply not buying it. At the risk of oversimplifying, the crisis in
Greece is too obvious a problem. Every investor, banker and politician
in the world is currently hypersensitive to the risk of another
financial meltdown, and all that recent fear is, I believe, the primary
reason such a catastrophe is unlikely to come to pass. Not in Greece,
and not anytime soon. While it seems slightly more possible that the
current woes in Europe could slow down the ongoing recovery in the
U.S., this is not a fear I am currently losing any sleep over. I suppose I should also acknowledge that "market sentiment" is poor right
now, and that there is
a real risk of a self-fulfilling prophecy when it comes to credit
fears, but, again, I do not view either as a reason to not to invest.
What I Expect to Happen
My predictions:
1 - At some point very soon, and quite possibly by the time U.S. investors wake up Monday morning,
Europe will have figured out a plan that satisfactorily
addresses Greece's short-term issues and begins to reduce the
threat of contagion. And the Dow will rise 251 points. Or 253 if Sagittarius is visible in the east.
2 - Despite few people talking about it, the scenario with the
highest odds will actually occur. More specifically, Greece
with all its woes will be able to grind things out for a couple
of years, thanks to an epic bailout courtesy of its neighbors
and the IMF. However, because Greece doesn't control its own
currency - it's tied to the Euro - it can't inflate away its
own debt, meaning the probability of default a few years down
the road seems pretty likely. That day will be an unpleasant
one, but it will also be far less significant than were it to
occur, say, next week, if for no other reason that Europe's
banks will be healthier and better able to withstand the blow.
Probably most important, however, is that in absolutely no realistic
scenario related to Greece over the next few days, weeks or
months can I foresee anything that would keep me from buying
lots of shares of Google as it trades under $500. That's just
silly.
What I Intend to Do About It
While there are certainly some risks like Greece to keep a
close eye on lately, the odds of any one of them becoming a
problem worthy of this recent volatility appear to be low. If
those odds increase to a point at which I become uncomfortable,
then I will not hesitate to move portions of our portfolio to
cash and wait things out. But you should know that I am nowhere
near that point.
In fact, I have been adjusting our positions in Tarpon
lately to put more money to work in our most undervalued
companies. Google is now our largest position. Leap Wireless at
$14 is a gift. And, oh, what I'd give to be starting a brand
new position in Neutral Tandem right now at $13. Not because
I'm being cavalier, mind you, but because these companies seem
so clearly undervalued and the short-term risks seem so
overblown. In addition, despite the fact that nobody seems to
want to believe it, the economy is, in fact, recovering. Yes,
it's going to take a while, and, no, it doesn't mean the end of
bad news, but both points are entirely consistent with the fact
that we are coming out of the worst recession most of the
country has ever seen.
Should my previous two predictions be way off, or if the
market continues to decline anyway, there are multiple
scenarios for Tarpon. The first is that, as mentioned
previously, I move things to cash. The second is that through
inverse ETFs, I actively short the market and/or select
sectors. The third scenario, however, is most likely, which is
that the Tarpon Folio begins to have larger positions in fewer
names, or adds modest positions in new companies. While I'm pleased
to see my watch list look more attractive lately, I'm even
happier that the most attractive stocks to buy are already in
the portfolio. To summarize my intentions, then, I'd reiterate that while
there is a low probability of the woes in Greece directly
impacting us here, I intend to keep a close eye on things
nonetheless. So, in Dynamite I will sit, watching and waiting
for the day when I can go back to completely ignoring opinions
about the credit default swap indexes of European financial
companies.
Speaking of Tarpon
In other news, here at IIM, I'm pleased to say we've added
23 new investors since I last wrote, with more coming onboard
in the next few weeks. As usual, these investors are extremely
good-looking, highly intelligent and the envy of all their
friends. If that describes you, too, but you're not yet an
investor, then have
I got a hyperlink for you.
As you might guess, I've been spending most of my time in a
cave lately, in part to stay on top of the swings in the
market caused by these once-every-few-decade-type events
that pop up every week. Health care reform.
Financial regulations. A massive oil spill. Near-catastrophic
trading glitches. A blessedly moronic car bomber. The Dolphins
trade for a real wide receiver. At this point, it also may be
easier for Goldman Sachs to clean up that tragic Gulf oil spill
than its own reputation.
Most of my time the last few months, however, has been spent
looking at companies in one specific sector of the market -
regional banks.
Yep, go ahead...cringing is normal.
I am well aware that saying there is real value among regional banks is kind of like saying you can get a great deal
on a flat-screen TV in Kabul. Impressive values do exist, but
you absolutely must be careful - and it better be one helluva
TV.
I'm afraid many more banks will likely fail in 2010 - the
math just doesn't seem to work - but that general fear is also
hiding some attractive opportunities among what will be the
survivors. It may be hard to believe, but well-managed banks
are fundamentally very good businesses. And only recently does
it seem we're starting to see real signs indicating which banks
will win and which will twist in the wind.
So, at times the last few months I've felt a little like
Frodo in Lord of the Rings. I wouldn't have made the
trek to Mordor if I hadn't been strangely compelled by some
kind of irresistible force. More than once I stomped my hairy
feet, threw down my tiny cloak and almost gave up in despair.
But despite all the nightmares, I'm now pleased to have made
the journey.
Too much with the metaphors?
Investors in Tarpon can check their accounts to see which
bank we now own. If you're not an investor, I'm afraid you're
going to have to wait until my next letter to learn more about
this latest holding. My apologies. As mentioned before, though,
I've got a handful of new investors coming onboard, and I want
to make sure they're fully invested before publicly disclosing
the bank. While mentioning it now probably wouldn't cause the
stock price to jump - it might even drop because of that
Frodo thing - I am also conscious of the fact that this email is
going out to a list that has somehow grown to over 600 people.
And it appears some may be, well, kind of influential. (Not
you, though, Greenspan.)
So, I'll be including a detailed report on Mystery Bank in
my next letter. I'm putting a little more time into it than
normal because, quite frankly, people are terrified of Mordor. Rest assured, though, that I believe the
trip was worth it.
More Thoughts On The Way
No doubt due to the choppiness of the market lately, and even before Greece popped up last week, a few
of you had expressed some unease about the economy and
investing in general. I owe you all some detailed macro thoughts. Here
are some quick thoughts in the meantime:
There are clearly a number of serious economic and
market-related issues that we as a country need to work through
over the coming years and decades. Nonetheless, I remain very
optimistic about our portfolio, and again, there are clear
signs that the economy is finally beginning to recover. I'm not
sure how to say this without sounding masochistic, but all
things being equal, I prefer the volatility we're
seeing lately. If you are investing now for years to come, these wild
swings provide the rare chance to accumulate meaningful
positions in some amazing companies. Most investors don't think
like that, of course, but as I write, the most popular free app
for the iPhone is also - and I am not making this up - a program called "Ow My Balls!" So,
draw your own conclusions about popular opinion.
That said, one potential macro headwind that does have my
full attention is the threat of future inflation. I'll soon
share some more thoughts on inflation and my plan to minimize
its impact on Tarpon, too.
In the meantime, I don't blame you if you have
post-traumatic-financial-crisis-syndrome. But hang in there
with me. We're starting to do some buying again. I'll provide a
more traditional update again soon. And by all means call or
email if you need to.
Thank you again for investing with us.
- Cale Smith
Portfolio Manager
Tarpon Folio
[email protected]
(305) 522-1333
|
Cale's
Notes: 