Are you a believer?
When I talk about FatAlpha, I always tell people who look at my strategy to ignore the stellar performance. This is something any investor should do when they look at any fund or portfolio manager. Two of the most important questions are: a) Do you currently have an allocation or interest in the manager’s investment universe? Someone interest in bonds shouldn’t be looking at equity strategies, nor one who focuses on a different geographical region, and b) Are you a believer in the strategy’s foundation? FatAlpha’s foundation has always been value investing. Someone who doesn’t believe should look away. It’s like a religion. You must believe both during the good times and the bad. Those with little faith suffer and experience lower investment returns as they jump from asset class to asset class and strategy to strategy. See this link to my twitter which shows asset class returns https://goo.gl/cXWNOZ. For example, as investor who was scared out of his mind at the end of 2008 and got heavily involved in Muni Bonds (the best performer in ’08) experience underperformance in ’09 and ’10. Those who got long MLPs at the end of 2013, ended up making little to nothing by the end of 2015.
So as I look back of 2015, what do I see? I see an upside down market. A year in which growth stocks beat value by a wide margin. (S&P 500 Growth returned 5.51% vs S&P 500 Value -3.14%). In an updated FT article, John Authers, writes “Had it not been for a small group of nifty companies, 2015 would have entered the history books as a terrible year for the US stock market”. Peter Atwater of Financial Insyghts agrees, as he wrote before the rate hike, “the top 10 stocks in the S&P 500 are up 13.9% while the other 490 are down 5.8% – the largest spread since the late 1990s!”
S&P Capital IQ uses a star system to rate stocks they recommend. From 1986 – 2015, the average annual performance of the 5-star portfolio is 13% while the 1-star portfolio averages 2%.
Notice what happened in 2015: The 5-star portfolio dropped -5% while the 1-star portfolio rose 8%. Personally, I don’t pay attention to what analysts rate my holdings, but this significant discrepancy versus historical was worth noting as it helps paint a picture of what we faced in 2015.
Market gurus haven’t fared well either, even if we ignore Ackman’s -20% due to his high concentration in Valeant (VRX). Greenlight’s David Einhorn lost -20%, Jana Partner’s Barry Rosenstein lost -5%, Third Point’s Loeb lost -1%, and the Oracle of Omaha, Warren Buffett lost -12%.
So basically, unless you were invested in a few highly priced momentum stories, you didn’t do too well. So I judge FatAlpha Active return of -0.6% as respectable. The benchmark SPY (S&P 500 ETF) returned +0.8%. The underperformance was due to December’s -5.1% vs the benchmark’s -2.3%. Personally, I was pleased with the portfolio composition which saw some additional purchases being made. Investors should recognise that in this business there are no certainties and so the most important thing is to control what you can – in other words the portfolio and its investment style. In last month’s letter I highlighted that I wrote an article on Stage Stores (SSI). It was a unique opportunity and those that followed along saw an 18% rise over the month of December. This month I wrote a piece on Micron (MU) that received some extreme responses from both the bulls and the bears (http://goo.gl/fn2iHW) and an article on Trinity Industries (http://goo.gl/IdjsjS). The Trinity article is restricted to PRO users while MU is available for all. My main three points on Trinity are: 1) The stock is cheap as the negative view from the market is overdone, 2) The current litigation will turn out to be a positive catalyst as the outcome will be better than expect due to the weak case (FYI, Trinity’s guard rail has passed all official and standardized safety tests), 3) The significant backlog results in a 2016 P/E of 6x. TRN has some flexibility in its railcar production and even if the company misses the lower end of guided deliveries is still a single digit P/E stock. The market appears to be already pricing in a significantly worse 2017. I believe that’s way too far off to think about right now or to place any trust in such a long-term negative prediction. Regardless, the market continues to hammer it down along with oil prices.
There are currently 19 total holdings in the portfolio which has been net long with almost no short positions in 2015, but this will most likely change in 2016. Since the inception of the FatAlpha Active strategy in 2012, this is the first time I am shifting my view away from bullish. A few 
of the things that trouble me: 1) The current market valuation has nowhere to go. According to FactSet, “For Q4 2015, the estimated earnings decline is -4.7%. If the index reports a decline in earnings for Q4, it will mark the first time the index has seen three consecutive quarters of yearover-year declines in earnings since Q1 2009 through Q3 2009.” 2) The market has been weak (an equally weighted S&P 500 is down -3.5% see: http://goo.gl/BCcl2A), and a down December is a warning sign (historically the market has gone up in December 80% of the time), 3) The yield curve has been flattening and as Yra Harris puts it all hell could break loose as central banks lose control (a must read post in Yra’s excellent blog: http://yragharris.com/2015/12/28/crazy/ ), 4) The market have been distorted by central bank intervention. This may have been needed back in 2008 but its continuous presence will result in future headaches. It is the actions of the central banks that will bring on the next crash. As in 2008, the crash will not be the result of excessive valuation (eg. 1999) or hyperinflation. The problem is that this time around, there is no ammunition left for the CBs. And I’m not going to touch on the plain stupidity of the negative yields and rates in Europe.
So what is the plan for 2016? Personally, I will execute for FatAlpha Active as I have stated in the past. See this article from 1-year ago: http://goo.gl/8E5pyd. This article was written before I developed the new market neutral strategy. In it I show that going long the cheap stocks and short the expensive ones could be devastating during strong bull markets. I argue in favor of a long exposure during bull markets and market neutral during bear markets. I believe this dynamic approach will enhance returns. Therefore in 2016 I will be added short positions but will remain net long until the monthly August low is taken out. That low is the swing low on the monthly chart and it is the remaining confirmation of change in the market. Once that is taken out I will be shifting the Active portfolio to market neutral by initiated shorts in two manners: 1) shorting expensive shares as generated by decile 10 of my value model, 2) shorting companies as generated by the short model used in the market neutral strategy (this model combines valuation with what I call red flags).
The new FatAlpha Market Neutral strategy was launched in September 2015 with personal and institutional money. During December is gained 1.8% vs -0.9% for its benchmark (Market Neutral ETF: CHEP), and closed the year up 3.3% vs -4.3% for CHEP.
Overall investors should expect a difficult 2016 with more volatility. Pending the August low holds, my base case scenario is for one more final run to the high. Then we will see the market moving sideways until it breaks. I’m focusing on that monthly low and so should you. Once that is broken, all bets are off. The monthly will be in a downtrend, while the daily will be below all significant moving averages. The fundamentals are already broken, and the technical level is the only thing left holding this market up.
Have a great year!
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