What follows is the "Looking Ahead" portion of my monthly letter to investors at T11. I have created an email list that sends this report out at the beginning of each month to those interested. The full report contains commentary about the general markets and individual positions held in managed portfolios, as well as overall performance. To be added to the list email me at mail@T11Capital.com
If there is one thing I have consistently been reminding myself of recently it is the benefit of keeping an open mind with respect to the general market for the remainder of 2014. It would behoove those interested in capitalizing on equity appreciation for the remainder of the year to follow the same path.
The nature of the current market is unlike any we have experienced in recent memory. There is a tremendous amount of dislocation taking place between popular averages, with uncommon divergences becoming the norm rather than the exception. There is also a tendency towards sideways movement that is becoming extremely compressed in nature. In fact, through May 23rd, 2014 is the first time in market history that both the Dow and Nasdaq are within 1% of unchanged for the year through May. Growth names have suffered dramatic corrections. However, the remainder of the market remains content with sitting still.
The greatest challenge affecting investors in the current environment is that general market conditions are being disproportionately lumped in with growth related investments. Growth does not constitute but a fraction of the market. Companies like Google, Facebook and Yelp are components of a terrific acceleration in technology. They are not the be all and end all of markets.
The current attitude that pervades investor psychology is undoubtedly brought about by past experience. More specifically, the experience of the internet bubble and the credit crisis, where the bursting of two distinctly separate excesses in the economy collapsed everything around them. Similar to a blast wave from an atomic bomb, there was little left standing in the aftermath of each crisis, irrespective of a company's specific merits.
It goes without saying then that investors would see to it that in the modern day rendition of a bull market old psychology would pervade the new, disallowing investors the privilege of accurate interpretation of current events.
The grace and ease with which the current bull market has dealt with the difficulties in the growth sector during 2014, essentially allowing these companies the privilege of correcting their excesses while the Dow and S&P remain tightly wound, should be seen as an indication of strength rather than a signal that a collapse of ALL sectors is imminent.
Further, the ability of investors to digest the rotation out of growth in a logical, unemotional fashion speaks of the abundance of institutional, experienced money that exists in the current marketplace. The institutional equity investor is much more micro-minded, with the distinct ability to discern sector excesses and inefficiencies in a completely unbiased manner. This results in the ability to form a bearish opinion on one sector of the marketplace without allowing that bearish opinion to infiltrate the entirety of that investors psychology.
This is opposed to the traditional retail modus operandi of concentrated allocation to specific sectors without the ability to rotate in an opportunistic fashion. The lessons of 1999-2000 was perhaps the best modern example of this retail portfolio structure infiltrating every crevasse of the equity markets eventually causing institutions to succumb to demand, creating products that were concentrated in nature, insuring that the fire exits would not accommodate the eager patrons crammed into the performance hall.
What the markets have told us thus far in 2014 is that responsible hands are holding the reins, allowing for excesses to be neatly extinguished without emotionally charged decision making allowing the creeping effect of bearish bias to infiltrate unrelated sectors of the marketplace. A classic healthy rotation scenario that is the hallmark of any bull market, in other words.
It hasn't been just growth that has seen a compression in price. Small/micro cap names have also witnessed a significant pullback, with the Russell 2000 being down 11% from peak to trough. Digging further down into where our investments are concentrated, the micro-cap index (IWC) has witnessed a pullback of 15% from its March peak to its May trough.
Speculative capital has been increasingly fleeing the markets, while investment capital of the responsible nature has been remaining steadfast in its vision of what lies ahead on both the micro and macro front.
The overriding theme here, despite all the noise, news to the contrary, skepticism about Wall Street in general and skittishness of investors far and wide is that this is a supremely confident and steadfast bull market. A very simple statement that is without exception overlooked in favor of having an ear to the nonsensical, infinite chatter that has become modern day investing.
At their essence, financial markets are a very simple tool for wealth creation. They rely on the near magical effects of compounding interest to levitate net worth through time. “Through time” equates to the long-term effect of wealth creation. It also refers to allowing an investment to work for you, instead of you as an investor working for that investment. The investors responsibility is to simply sit tight during advantageous market conditions.
The propensity and hunger to ring the cash register prematurely is the greatest failure of the modern day investor class, both retail and institutional. It is a direct result of an investor's thesis never having solid ground to rest on due to the constant bombardment of conflicting information be it micro and macro in nature.
At T11, my universe of investments is about ten stocks deep. Our current portfolio has only a handful of investments with only several more that I would consider adding sometime during 2014. This type of intimate familiarity with current and potential investments allows for a significant degree of comfort and confidence that allows for concentrated positions that make a tangible difference in outperformance relative to any benchmark.
The goal in our exposure is to be correlated to nothing other than the quality of the ideas and research that I put together. This goal can only be accomplished by a) seeking out opportunities that are far off the radars of both retail and institutional investors b) concentrating exposure so that the quality of our ideas and thus performance that results from it is “felt” to the maximum degree possible without compromising results due to extreme volatility.
Further, the ability to rotate opportunities within such a strategy based on perceived risk/reward over the intermediate to long-term will only enhance results. In 2014, our results have been enhanced rather dramatically from a consistent focus on opportunistic rotation within my small universe of companies.
In assessing our outperformance thus far in 2014, all of the aforementioned have played key parts. Our exposure, while being heavily concentrated at present, is reflective of the best opportunities the market has to provide. Opportunities that remain highly asymmetric in nature, with dramatic hidden value that neither Wall Street nor Main Street is built to dissect properly.
With this in mind, I not only believe our outperformance in 2014 is sustainable but can be enhanced going forward as the hidden value of our positions becomes apparent into year end.
Finally, investment managers are incorrect in believing their job is to create returns for investors. It is not my job or any investment managers responsibility to create returns. It is the process that creates the returns for an investor. My job is to simply be a steward of the process. The returns are simply an aftereffect of being a responsible steward of a competent, effective process.
As we move into June, here is to remembering the often unmentioned and overlooked aspect of the stewardship of one's process being the most important responsibility an experienced investor faces on a day to day basis.
