FatAlpha’s performance in February was mainly affected by one of it’s largest positions: Trinity Industries. I had reduced the position some time ago, however I became more bullish on the stock following the Q3 results and conference call in October. This was a company that had double-digit earnings growth, beating expectations, its own guidance and trading at a single digit P/E. Furthermore based on Q3 guided deliveries for 2016 and strong backlog, a 10x P/E based on my estimates which agreed with Bloomberg’s resulted in a 50% upside. As a result I increased my position.
Q4 again beat but guidance was shockingly lower. Based on the evidence (see my latest article on TRN: http://goo.gl/HMHJ4k), management purposely did not communicate the risks earlier. To cut a long story short, I expect things to get worse for TRN and its shareholders and have exited the position completely. TRN dropped around 25% during the month and wiped out more than 1% of return for the Active Strategy and over 0.50% for the Market Neutral Strategy. For the month, the Active Strategy lost -0.8%, while the Market Neutral gained +0.9%.
I continued during February to reduce my net exposure and it is currently around 42%. This was due to reduction in positions. Besides TRN, I also exited Abercrombie (ANF). ANF was a great investment which I didn’t fully benefit from as it remained a small position. I also took partial profits in Sanderson Farms. Regarding exposure, I have been asked why I don’t establish FatAlpha Active as a long only strategy, since I already have a market neutral strategy. The argument is that by changing exposure, I have introduced essentially a market timing element. The risk being that the stock picking continues to do well from the value long side but suffers due to the shorts. To those friends who have questioned me on this, my answer was: a) I only intend to change the exposure during a significant change in the market. Some of the reasons outlined in this article: http://goo.gl/rZoEC8, and b) My own savings are at stake and if I strongly feel the bull market is over, I obviously do not want to lose money for the sake of not introducing a market timing element.
As El-Erian said, “The system is not built to operate at negative rates thoughout the world”…”something will break”. And I believe that either in 2015 or 2016 something will break. Perhaps I am early. Perhaps the Fed and global CBs further inflate asset prices. But I’d rather be a bit early and miss a bit of upside but protect my hard-earned cash. I expect to generate some good returns via shorts when the market crashes. Because it will crash. It’s not a matter of if but when. My friend Prinn from Thailand asked me what I thought would be the catalyst. To be honest I don’t know which will be the specific catalyst. We have the energy debt overhang, Europe, Greece, Japan, China, and Brexit. What I do know is that the data currently tells me that the bull is dead and a crash is a very probable event. There has been a lot of wishful thinking recently with the surprisingly strong rebound that I expect will trade a lot of retail investors. PMI beat expectations at 49.50 but it remains below 50.
As the chart shows, this remains a very negative sign for the markets. Let’s also not forget the below (from zerohedge.com):
On oil, see the interview Warren Buffett gave to CNBC (page 3 above). Buffett, like Mauldin’s piece discussed last month talks about how wealth disappeared and the resulting domino effect. . A lot of this new spending that came about from energy is gone forever and this is affecting companies beyond the energy sector. For example: engineering and construction companies (JEC), retail (SSI, DDS), railcars (TRN), etc. So it has been practically impossible for portfolio and fund managers to not have been affected in one way or another. Bulls like to remove energy from S&P calculations but that is wrong for many reasons. Firstly, are we calculating new multiples historically by removing the worse sector from the index every year? Obviously not. Does the US all of a sudden don’t have an energy sector? Obviously not. Will we be removing all companies (like those mentioned) that are affected by energy also from the index? Obviously not. Are energy earnings also ignored for 2016? How about 2017? So when should energy be included? When oil returns to $100? Isn’t the logic all too convenient to the bulls but makes absolutely no sense. Finally, consider this: How strong is the market when it rallies only based on oil? I’d say “Not strong at all”.
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