During May, the portfolio made a comeback rising 3.11% vs 1.29% for the S&P 500. That puts FatAlpha at 4.6% vs 3.6% for the benchmark for 2015. Large gains were recorded by GTS (on earnings, up 28%), CBI (Einhorn upped his stake, 14%), GME (on earnings, 13%), TRN (bounce from last month, 11%), and ANTM (11%). On earnings, CTB dropped 14%, while KSS and ANF both dropped 9%.
Volatility has increased as investors are making hasty moves, selling one day and buying on another. For example, ANF rallied on earnings only to lose it all and more on a downgrade the next day. This has been a repeated theme the last two months, and could be due to the maturing of the bull market. As I showed in last month’s letter, price action has been overlapping (see repeat of chart below). Fundamentals aren’t terribly exciting either with the S&P trading at around 18-20x earnings. Despite this I believe this sideways action with short-term moves taking brief peeks at the highs to continue until we have a trigger event (unknown currently but could be rising rates, a Greek default, etc).
In the meantime, you have to be careful not to overtrade and to stick to your strategy. It’s tough being a value investor but it’s also the reason value will continue to outperform in the long run. Who wants to hold shares in a company with declining sales and profits? Tough to get excited about that. It’s much easier to look through all the great companies that are doing well, but that’s what everyone is doing. And that’s why they are no longer cheap. If we look at the Russell 3000, we will find that only 525 companies have increased sales and operating profits in the last eight quarters consecutively. Every other company either had one or more down quarters in either sales or operating profits. Furthermore, if we look at that short list, we will find that only 24 of those companies are in the cheapest decile (not a very popular group). In contrast, around half of the 525 companies are in the 33% most expensive stocks in the market.
So as value investor we lean against the cheapness and not the fantastic company operating performance to help us make our return. As a result our biggest risk is always the value trap. The Radioshacks and BlockBuster Videos of the world. There are ways to help filter out the risks but it’s a significant risk that constantly needs work at. This is what I’ve been thinking about, this past month as I have reduced my position in HPQ and XRX. Your ideal scenario is ANTM (ex WLP) when it gets extremely cheap but operating performance is still there and continues. But ANTM is more of an exception rather than the rule. Value stocks are cheap because of the increased uncertainty and unpredictability of what is to come. Reflecting on XRX, the stock reached $14+ in late 2014. I was long the stock from $10-11. I wasn’t satisfied with the operating side of the business but my models still gave it as cheap. So I took the view that if I sold it what would I be replacing it with? And to hold on until it moved out of value. The stock is still in value but in the $11-12 range. Now applying this same approach to ANTM and holding on was gold, as the stock more than double from my entry. So lesson is that sometimes you need to be a little flexible. But at the same time, you need to be careful when to apply one approach and when not too as you may leave too much on the table. Not to mention potential overtrading….
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