MARCH CLIENT LETTER: CONFUSION IS THE PATH OF LEAST RESISTANCE; LEGISLATIVE MORASS; SOME INTERESTING CHARTS
Apr08

MARCH CLIENT LETTER: CONFUSION IS THE PATH OF LEAST RESISTANCE; LEGISLATIVE MORASS; SOME INTERESTING CHARTS

What follows is a section from the “Thoughts & Analysis” portion of my monthly letter to investors at T11 Capital.   Confusion Is The Path of Lease Resistance It remains an extremely simple exercise to look at the circumstances surrounding the current evolution of this bull market and determine that it cannot last. Not much has changed since the inception of this secular bull market in 2013. Doubting the ability of equities to ascend remains the path of least resistance. While it is true that bull markets climb a wall of worry, that wall of worry is often times built on facts that markets do not immediately become concerned with, instead choosing to revel in glorious optimism without concern for what lies dormant in the background. In fact, one of the lessons of experience in finance is that markets very often take longer to react to important developments than one would suspect. The emotions of the day very often take precedent over relevant facts, whether micro or macro related, that have very real consequences for the economy, earnings etc. The markets do a wonderful job of behaving in a nonchalant fashion as important changes occur that immediately concern market observers who then decide that given the markets predominance in one direction, their concern is unwarranted. The important fundamental shifts occurring in the background never go away, of course. They simply lie dormant awaiting the moment when the emotional tank of investors moves to empty. This applies to individual stocks just as much as the broader markets. Individual stocks, especially in my favored category of sub-$500 million in market cap, can take months or years to awaken to fundamental developments that have been percolating in the background while the stock price languishes causing a majority of investors to think that their analysis was wrong, when in fact, their analysis was simply on delay. Companies can often times experience multiple years worth of gains in just a few months as they catch up to the fundamental realities that investors suddenly awaken to. Much like a badly dubbed Chinese Kung-Fu movie where the words are heard before the mouths of the actors begin moving, there is an inherent delay in individual equities and the markets in realizing important fundamental developments. More often than not, the confusion that most investors experience is a result of this delay, giving rise to often used descriptive terms to describe the markets such as illogical, counter-intuitive and contrarian in nature. Markets may, in fact, be much more logical than we realize. However, they are also much less efficient in factoring in relevant developments than we realize, as...

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FEBRUARY CLIENT LETTER: A MAGNIFICENTLY PERILOUS ALTERATION IN THINKING
Mar07

FEBRUARY CLIENT LETTER: A MAGNIFICENTLY PERILOUS ALTERATION IN THINKING

What follows is a section from the “Thoughts & Analysis” portion of my monthly letter to investors at T11 Capital. There are preconditions to this current phase of the bull market that will only become obvious in hindsight to most investors. Those preconditions involve the price that is to be paid for the nearly unbridled enjoyment of the past several months by a majority of investors. That enjoyment is a marked change over any rally of the past several years, going back to 2009. As with any change, there are tradeoffs to be made for beneficial conditions that involve new participants with a completely reformed mental attitude towards the markets. Whereas from 2009 to late 2016, there was the perpetual hum and sway of skepticism towards the markets, the rally from November 2016 to present has disposed of skepticism, fear and trepidation, in exchange for optimism, jubilation and to a certain extent, greed. The entire framework of the rally, therefore, has been altered from November 2016 forward. The price to be paid for this alteration in the framework or code, if you will, that is underlying the current rally is likely one that most investors are unprepared to face. That price comes in the form of increasing, sudden volatility on the downside that will become more frequent and pronounced as the rally continues. Gone are the days of simple 5-7 percent pullbacks with the occasional 10 percent pullback that is met with an almost immediate trembling fear taking over market participants. The fundamental backdrop does not justify getting scared after a 10 percent pullback any longer given that investors now have concrete fundamental facts from which to justify buying dips. Since the markets are hell bent on inflicting the maximum amount of pain to the maximum number of participants, the shakes have to increase in amplitude. The dips have to command the emotions of investors before they reverse. The same investors that were hedging, selling and selling short stock after a 5 to 10 percent dip in the markets now have the following logical assumptions to draw from that simply didn't exist at anytime from 2009 to late 2016: I will buy the dip in financials because deregulation will increase profitability I will buy the dip in financials and insurance because increased interest rates expand profitability I will buy the dip in industrials because there is a resurgence in domestic manufacturing I will buy the dip in industrials because infrastructure spending will boost earnings I will buy the dip in oil & gas names because domestic energy production is a priority for the current adminstration I will buy the...

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JANUARY CLIENT LETTER: THE THING ABOUT CONSENSUS VALUE
Feb04

JANUARY CLIENT LETTER: THE THING ABOUT CONSENSUS VALUE

What follows is a section from the “Thoughts & Analysis” portion of my monthly letter to investors at T11 Capital. Some of the greatest opportunities in the financial markets are those where value is allowed to be cultivated through an incentivized management team. The more difficult to assess the value of a company, as a result of a mix of esoteric assets and restructured operations, the more likely it is that the market will misrepresent the value of the company. The smaller the market cap, the greater the discrepancy in value. The aforementioned are all fairly obvious points to the experienced investor. Obviously, in areas of the market where less individuals and institutions are paying attention, those areas will be prone to substantial dislocations in value. And perhaps even more obviously, individuals are driven by incentives. Without them we become lackadaisical, mouth-breathing neanderthals that would be perfectly content spending our days trying to beat the high score in Candy Crush. Incentives drive human behavior, creativity and in the end, the realization of value in undervalued corporations. What is missing from the formula is everything that takes place in between the realization that value exists in a company and an incentivized, experienced management team put in place to expertly help in realizing the value. There are literally countless individuals who have spotted the correct alignment between value and incentives, yet there are few who are consistently able to outperform the market. The realization, in fact, that a value/incentive aligned situation exists is very often a consensus event. A consensus value event is one where a majority of individuals observing the company believe that value exists in the corporation and eventually the share price will be substantially higher. A consensus value event is not attempting to pick the bottom in a violent, macro driven decline in oil, for example, as we experienced exactly 12 months ago. A consensus value event is also not attempting to pick the exact bottom of the financial crisis by purchasing a basket of stocks in March of 2009. These are contrarian value events, which is a topic for another letter. The difficulty investing in a consensus value event comes from an inherent conflict with the basic functioning of the financial markets, generally. Consensus is essentially an abomination in the financial markets. Markets will go through inordinately painful measures that completely lack any rationality to eradicate consensus allocations and investments in the markets. In fact, many popular quips exist that attempt to simplify the action: The markets can stay irrational longer than you can stay solvent; losers average losers and so on. In order for the markets...

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THE BRILLIANTLY PERILOUS TIMES AHEAD
Jan20

THE BRILLIANTLY PERILOUS TIMES AHEAD

What follows is a section from the “Thoughts & Analysis” portion of my monthly letter to investors at T11 Capital. A sense of absolute clarity has suddenly developed within the minds of investors in U.S. equities. A clarity as to the future of the economy. A clarity as to the future of the markets. A clarity as to the future of their own personal fortunes. This clarity has been thrust upon the hearts and minds of investors from one source: Government. The changing of government that will take place in earnest later this month ushers in an incubator-esque, pro-business environment that the country has never experienced. It is only appropriate that in the face of pro-business policies, designed by individuals who have a lot of money, for people who want to make a lot of money, that the markets would applaud loudly by driving up equity prices to record levels over the past couple months. That very same comfort and clarity, however, creates some of the most perilous conditions we have had in all the time the markets have been advancing since 2009. There is a premium that has now been baked into the market based on governmental policy and action. In the past years, we have only seen premiums baked into the market for earnings and monetary policy reasons. The current affinity for fiscal policy, whether in the form of stimulus or deregulation, reflected in the premiums individuals are suddenly willing to pay for stocks, changes the game completely going forward. Investors have now tied themselves to a group that has influences from an infinite number of outside groups that have contradictory interests tied to numerous other groups. This is no longer a game if earnings are good then markets will rally; if monetary policy remains accommodating then the markets have a base from which to rally; if geopolitical and macro uncertainty stays out of the picture then the markets will appreciate in value. Things just got a lot more complicated while investors have become extremely comfortable with their investments. How comfortable? Take this comment from the CEO of Trimtabs as one example: “The stampede into U.S. equity ETFs since the election has been nothing short of breathtaking. The inflow since Election Day is equal to one and a half times the inflow of $61.5 billion in all of last year.” Investors, in other words, have digested all of the positive soundbites coming from various media sources and have concluded unanimously that they are underexposed to equities. And this note from Bank of America courtesy of ValueWalk: ETF buying by Bank of America’s retail clients was the fourth...

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SEPTEMBER CLIENT LETTER: LET’S GET NORMAL; A WICKED GAME TO PLAY; BUY COMPLEXITY, SELL SIMPLICITY
Oct11

SEPTEMBER CLIENT LETTER: LET’S GET NORMAL; A WICKED GAME TO PLAY; BUY COMPLEXITY, SELL SIMPLICITY

What follows is a section from the “Thoughts & Analysis” portion of my monthly letter to investors at T11 Capital.   The stock market is a giant distraction from the business of investing. ---- John Bogle Let's Get Normal The Delivering Alpha Conference took place in September. Delivering Alpha, for those who are not familiar, is basically a conference where high level fund managers take the stage for an interview where they discuss opinions about the markets, economy etc. Here is an excerpt from an interview with Marc Lasry of Avenue Capital worth noting: Caruso-Cabrera: We were chatting and we had our conference call beforehand. And you made the point in saying that a while ago you gave up on quarterly redemptions. If you want to give me your money, you have to give it to me for three years. No more hedge fund. Why? Avenue Capital Group CEO Marc Lasry: Because I think it's gotten extremely difficult to invest on a quarterly basis. I think before, when you weren't in a zero-rate environment, a zero-interest environment, it was actually easier. But now, you actually need the luxury of time. And because sometimes things will go down, so you need to invest over a sort of two or three year period. Or not have people who get nervous who automatically want their capital. And I didn't think we could generate the returns for people if we did that. So mainly we just went to our investors and said we're going to shift anybody who is here to lock up to about three years. And whoever doesn't want to do that, you can leave, and about 75 percent of the money stayed and 25 percent left. In recent years, it has become of increased importance to recognize that the runway towards an investor recognizing value in a stock and the market recognizing that same value has lengthened substantially. The markets as a whole have become reluctant to assign value to uncertain situations. Given that we just so happen to dwell in the realm of murkiness and uncertainty, this dynamic will certainly effect the pattern of returns until the dynamic changes or our positions move into more certain fundamental positions that will lead to a sudden rush of value creation. What we are truly experiencing in the current zero yield market environment is an expression of emotion rather than an expression of intellectual understanding. Investors globally are telling us that they are too fearful, skeptical and indelibly scarred to put capital at risk. This is an extreme emotional reaction to unprecedented action by global central bankers caused by a once in...

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AUGUST CLIENT LETTER: THE SMALL-CAP MARKET OF 2016; “I’D RATHER EAT ROCKS THAN BUY STOCKS”; THE NARROWS
Sep08

AUGUST CLIENT LETTER: THE SMALL-CAP MARKET OF 2016; “I’D RATHER EAT ROCKS THAN BUY STOCKS”; THE NARROWS

  What follows is a section from the “Thoughts & Analysis” portion of my monthly letter to investors at T11 Capital.   The Small-Cap Market of 2016 Since 2014, small-cap investors have been treated to a sideways market, with a 27% peak to valley drawdown thrown in for good measure. The pricing environment for small company shares paired up with a near chronic pessimism that has incrementally advanced since the 2009 bottom has led to a trading environment that is tremendously illiquid and severely mispriced in certain areas. In small-cap investing, there will always be pockets of mispricing as the market simply is not efficient enough to correctly price thousands of companies with scant or nonexistent analyst coverage. This simple phenomenon leads to the opportunities that become available to investors over time to profit from these blatant inefficiencies in the marketplace. In 2016, however, the simple phenomenon of mispricing has taken on a new slant. Securities pricing is being graded by difficulty. The more difficult the situation, the more likely it is that the company will be mispriced. Companies that release relevant, easy to digest information regarding products or partnerships that are recognizable to investors are properly rewarded through premiums in share price. However, situations that are opaque, difficult or those possessing variability in outcomes are largely ignored. This leaves special situation/event driven investors reliant upon their analysis to be correct more than ever because the market simply won't assign a premium based on expectations of success, but on success coming to fruition in a tangible, recognizable way. In some ways, the public equity market for companies with market caps under $500 million has become similar to private equity or venture capital in 2016. Value is taking longer to realize in an environment that is not necessarily liquid but rewards tangible results over time. Gone are the days of blanket adjustments up in the price of shares based on a sector or general market movement. Companies are being left behind in favor of tangible performers with tangible products and partnerships. This leaves the special situation/event driven investor in a position that demands a mentality in step with the times. Managers have a relatively simple decision to make: 1. Conform to the current market cycle, seeking out opportunities that the market sees as relevant. Essentially becoming a growth investor rather than a value investor. 2. Adjust your mentality to fall more in line with that of a private equity or venture capital investor that is dealing in the public markets. Very simply put, assuming that you disagree with the first choice, deciding that maintaining an edge in the markets is...

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JULY CLIENT LETTER: THIS THREE YEAR OLD BULL MARKET; UNDERSTANDING FORM AND RHYTHM
Aug07

JULY CLIENT LETTER: THIS THREE YEAR OLD BULL MARKET; UNDERSTANDING FORM AND RHYTHM

What follows is a section from the “Thoughts & Analysis” portion of my monthly letter to investors at T11 Capital.   Thoughts & Analysis This Three Year Old Bull Market One of the many issues that investors face in the current environment is their inability to accurately gauge the age of the current bull market. The traditional argument has been and continues to be that the current secular bull market must have started at the 2009 bottom simply because stocks have been moving up since bottoming at 666.79 on the S&P 500 seven years ago. What investors seem to overlooking when they argue that a bull market commences at the point of reversal and subsequent long-term appreciation is context. The context that is being missed in our most recent example is that the S&P 500 had made a low of 768 back in 2003 after the secular top in 2000 to the 18 year bull run that started in 1982. The 2009 “credit crisis” bottom of 666.79 was a thorough retest of the 2003 lows, constituting what was essentially a long-term sideways range for stocks that is typical of the end of a secular bull run. For example, when the Dow topped in 1929, dropping from a high of 386 to 40 in 1932, the subsequent volatile sideways range took place over a span of 25 years, marking multiple starts and stops before a new all-time high and a new secular bull market started in 1954. Those who took it upon themselves to correlate the age of the bull market to the simple act of stocks moving up at that time were sold on the idea that the bull market was 18 years old simply because stocks bottomed in 1932. The truth of the matter in 1954 was that a secular bull market was just being born. A secular bull, by the way, that would triple the value of the Dow over the next 13 years into the 1966 top. Subsequently, a sideways range emerged that saw stocks go nowhere from 1966 – 1981. Along the way there was an initial bottom that took place in 1970 with a low of 627, which surely had market participants reeling after witnessing a near 50% drop from the all-time highs in the Dow just four years earlier. It didn't end there, however, much like the initial low on the Dow in 2003 after the mess leftover from the internet bubble started to mend, that would not be the ultimate low. The markets had one more bearish act in store for investors to completely dissuade them from purchasing equities over the next...

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JUNE CLIENT LETTER: FAILURE GENERATION; HEADLINE GAMES; THE SPORT OF INVALIDS
Jul06

JUNE CLIENT LETTER: FAILURE GENERATION; HEADLINE GAMES; THE SPORT OF INVALIDS

What follows is a section from the “Thoughts & Analysis” portion of my monthly letter to investors at T11 Capital.   The Failure Generation In no uncertain terms, we have been challenged extensively during the first half of 2016. Challenged as to the level of conviction in future economic prosperity. Challenged as to the level of faith in government to govern properly. Challenged as to the level of confidence in the financial markets. Challenged as to the degree of research into our tidy portfolio of three core holdings that have basically floundered in 2016. These challenges are being exasperated by a seemingly perpetual modern infatuation with failure. Everyone from media outlets to prominent billionaires to overly-sensitive millennials are gripped by a near obsession with failure. Economic failure. Individual failure. Corporate failure. Governmental failure. If there is failure to be had, it peaks the interest of all classes of individuals. Take for example the recent army of billionaires who have come out to proclaim imminent doom in the global economy and financial markets. It used to be that billionaires kept enlightened opinions to themselves as the biggest threat to a billionaire is another billionaire. Therefore, by disseminating enlightened knowledge they are only allowing the meager millionaire class to move into the billionaire status creating a form of self-cannibalization to a certain degree. Not in today's world, however. Billionaires are only too eager to tell us all how peasantry awaits any individual who trusts in the global economy to provide any form of prosperity going forward. Soros, Druckenmiller, Rogers, Icahn, Bass and Grantham to name a few. And those billionaires that aren't delivering news of imminent doom directly delegate the responsibility to messengers who tell us they have sat in a room full of billionaires who profess total allegiance to cash in fear of economic collapse. The failure generation has spoken most recently with the surprise vote for Britain to exit the EU. This time they have not simply expressed failure, but have voted for it, in the form of a long standing union failing to exist in its current form. The EU has failed, during a time when, not surprisingly, failure is not only the path of least resistance, but subconsciously, or perhaps even consciously, has become the path of greatest desire. When billionaires aren't discussing publicly the storyline of impending economic failure or citizens voting for the failure of a union, then individuals pass their time by openly and viciously hoping for the failure of the innovators among us. Nobody encapsulates “innovator” better than Elon Musk. Not surprisingly, he is the most derided individual in corporate America, with a...

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MAY CLIENT LETTER: THE HAUNTED HOUSE OF ZIRP & NIRP; MAY EDITION OF “I’D RATHER EAT ROCKS THAN BUY STOCKS”
Jun05

MAY CLIENT LETTER: THE HAUNTED HOUSE OF ZIRP & NIRP; MAY EDITION OF “I’D RATHER EAT ROCKS THAN BUY STOCKS”

What follows is a section from the “Thoughts & Analysis” portion of my monthly letter to investors at T11 Capital.   The Haunted House of ZIRP and NIRP Zero interest rate policy, more commonly referred to by the acronym ZIRP, has worked its way into the financial lexicon over the past year in a rather eloquent manner, followed closely by negative interest rate policy or NIRP. Financial pundits of all types have taken to the airwaves proclaiming ZIRP and NIRP as something that is an inevitable conclusion to the massive global monetary stimulus that continues to take place. Denmark, Sweden, Switzerland and Japan are all wandering into the haunted house of ZIRP and NIRP currently, wondering what lies in its hollow corridors and narrow passages. There is no guidepost for ZIRP and NIRP, as it has never been attempted in such a globally coordinated fashion. What lies at the essence of ZIRP and NIRP policy is a proclamation by global central bankers that cash is essentially worthless unless invested in a risk asset. This proclamation comes against a backdrop of investor skepticism of risk assets moving progressively higher on the curve based on the substance of the asset in question, with stocks being seen as the least substantive taking a backseat to tangible assets such as gold and real estate. Most recently, even centers of reliable increases in real estate prices that have attracted global assets, such as New York and San Francisco, have seen a general softness in prices develop as the uncertainty of this experiment in global monetary policy has taken its toll. What must be considered is that against a backdrop of enormous uncertainty created by a never before attempted policy of ZIRP and NIRP, will investor mentality begin converging along the lines of low or no returns available in all asset classes causing them to simply refuse to participate in all but cash for an indefinite period of time? Already global cash levels are at 15 year highs according to some measures such as the Bank of America Merrill Lynch Global Fund Manager Survey: Global investors' cash levels are currently pegged at 5.6% of their total portfolio, which is the highest in the past 15 years as many have opted for capital protection amid a volatile global market. This mentality towards capital preservation in the face of an attempt by global central banks to force investors out of cash tells us at a very basic level that investors see no returns as a better option than a negative return. We have to assume then that investor expectations for future returns are being tempered by the...

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APRIL CLIENT LETTER: REVERSIONS; TEPID BULLS ABOUND; HEDGEAPOOLZA
May08

APRIL CLIENT LETTER: REVERSIONS; TEPID BULLS ABOUND; HEDGEAPOOLZA

What follows is a section from the “Thoughts & Analysis” portion of my monthly letter to investors at T11 Capital. Reversions In stepping back and looking closely at the current portfolio during what has been a disappointing 2016 to date, I am reminded of a method of testing conviction in each portfolio holding as described by Lee Ainslie of Maverick Capital: When Mr. Ainslie reviews the overall plan, he is thinking about the size of every position. Mr. Robertson [for whom Mr. Ainslie worked in the early 1990s] taught him to test his conviction by asking himself if the stock is a buy or a sell. A hold isn't an option. This is how I've come to think of it over the years: Either this security deserves incremental capital at the current price point or it doesn't — in which case, let's sell it and put the money to work in a security that deserves that incremental capital," Mr. Ainslie said. At T11 Capital, I very much utilize a similar methodology in portfolio decisions. If at any point an investment gets to the point where I wouldn't consider adding to the position, then the investment should be sold. This has been one of the components behind our timely exit in investments like CIDM close to $3 per share, IMH near $21 and many others over the years, that have declined significantly following our exit. Not to say this methodology is foolproof (nothing is, of course) by any means. We have also exited SPNS near $7, it is now at $12. I decided to let go of MITL near $3 years ago, it is now trading at $7, after going as high as $12. Overall, however, this level of thinking with respect to allocation decisions rewards conviction brought about by depth in research. It forces an investor to constantly evaluate whether a holding is exhibiting the same positive attributes that caused an allocation in the first place, mitigating the numerous gray areas that often times end up being a weak or compromised thesis disguised as indecision. In closely reviewing our current portfolio positioning on an everyday basis, there isn't a position in our portfolio with the exception of our investment in the illiquid Lehman Capital Trust shares, that I wouldn't consider a buy at current levels. We are in possession of extreme value within a market that is playing a game of reversion to the mean of my particular method of investment. A situation, by the way, that is a natural phenomenon of investing, as well as being a component in the demise of many talented investors who feel the need to...

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