I appear to be semi-frozen
in my portfolio right now, not wanting to buy or sell significant parts of our
investments. I speak not only as a paid investment advisor who wishes to
continue to be paid, but also as a steward of my family’s and personal
accounts. The continuation of payment from a long-term strategic investor has
caused many advisors to make changes to portfolios look as if they are busy
earning their fees. While there are almost always chances of significant
deterioration of the long-term prospects of an investment as well as newly
discovered research/analysis that makes previously bypassed investments
attractive, many portfolio changes are disruptive and I suspect are done merely
to look busy. In managing my own and family money as well as serving pro bono
on investment committees, there is no need for me to appear to be looking as I
am in action rather than observing. Thus, these privately focused accounts are
a helpful guide to my professional responsibilities.
With those thoughts in
mind, I want to explore with you my current thinking about my personal rather
than professional investment duties.
Where are we in the current investment cycle?
Any study of history shows that in
almost any activity there is a pattern of expansion and contraction. Even in
terms of differing philosophies, they move further apart or become more
concentrated in some form of a Hegelian synthesis, until there is another
period of disruption of central tendencies. Cycles are endemic to human
behavior. Thus, we regularly find investment markets moving in a cyclical
format. We clearly had a market peak in
2007 and an economic/financial fall in 2008 and a stock market bottom in March
2009. Numerous commentators will use these dates to chronicle the latest
expansion with comments that some stocks and some funds have risen past their
2007 highs. The politically-oriented economists will focus on 2008 as the turning
point and surviving market investors will judge performance from March 2009. (I
suspect that many advisor “pitch” books and advertisements will start
trumpeting five year performance numbers as well as the consultants’ favored
three year period to show investment expertise rather than recoveries from
depressed levels.)
In the light of the above
thoughts, I look at my own personal accounts which are loaded with stocks of
financial services companies with heavy emphasis on investment managers and broker/dealers
both in the US and elsewhere. The
recoveries in general have been remarkable. Careful analysis of the names in
the portfolio can be grouped into two categories. The first are the leaders in
their segments which have recovered the most. The second group were perhaps
value traps; companies that were selling way below the cost to recreate them in
sectors that traditionally large companies wished to enter to fill out their
product offerings. While these have regained some of their lost ground in terms
of stock prices, they have underperformed the leaders. This dichotomy
between the two groups leaves me in a quandary and as usual I turn to the study
of the current market structure for a guide to the future different from the extrapolation
of current trends.
What
am I seeing?
The leadership group’s
stock prices are back into their “normal” levels; thus I continue to hold them
in the belief that if the current expansion cycle ends soon, I will want to
hold the leaders for the next expansion when we may see a full uplift to the
global economy and its needs for viable financial services leadership. Up to
this point I have labeled leadership companies without describing the basis of
their leadership. Statistically these companies are among the biggest in their
defined sectors, but not necessarily the largest. They have grown internally
without the benefit of large acquisitions, but with the occasional willingness
to bring a few talented outsiders into key decision making roles. Some of their
larger competitors were put together through mergers and acquisitions which
make their management focus on political decisions within their expanded empire.
Saturday night I was
thinking about the nature of great leadership. My wife and I attended a
birthday party for George Washington at his Mount Vernon home. (Actually it was
to celebrate his 281st birthday.) The speaker was Ron Chernow, the
author and historian, who discussed Washington’s leadership in his two terms as
president. What struck me was that General Washington, not Congress, created
the concept of a cabinet within the US government. His was only three: Hamilton
in Treasury, Jefferson in State and Knox in the War Department. He chose men
who were better educated and in many ways more intelligent than him. He
encouraged vigorous debate and tolerated strident disagreements, particularly
between Hamilton and Jefferson. Yet in his two terms as President, including
turning down a third term, he established more policies and better practices
than any of the presidents that followed him.
In my mind I applied
the lessons from Washington to my list of leadership companies’ attributes:
1. Attract
the best available minds, even those that are smarter than the leader (CEO).
2. Encourage
debate within a small select group.
3. After
listening to critical experts, the CEO should thoughtfully make up his/her own
mind.
4. Knowing
when to leave, hopefully at the top.
I will continue to look
for other companies with similar leadership attributes, hopefully with not too
demanding stock prices.
While I am content with
my portfolio’s leadership positions, what concerns me are the holdings in
companies that in some respects are worth more dead through acquisition than
currently alive. When I carefully analyze my bets in these companies, they are
really dependent upon market actions (or to be blunt, waves of speculation). At
this time I may have the winds at my back to push these stock prices higher. The
winds in my favor are:
1.
A rising tide of merger &
acquisitions as commented upon by Moody’s* and others. The credit rater is worried that these deals
will weaken the acquirers’ balance sheets. On the positive side, the stock
prices of a number of mid-sized investment banking firms are selling at above
market price/earnings ratios which seems to assume that they see their
earnings will rise on the basis of the fees they will earn by representing
buyers and sellers in these deals.
2.
The market appears to be concerned about
the apparent “take-under” of Dell, unless you see it as a discount that the
current owners need to pay to get out from under Michael Dell’s leadership. The
market responded positively to the surprise announcement of the purchase of
Heinz by 3G and Berkshire Hathaway*. Part of the positive reaction to this deal
was that it showed Warren Buffett’s technique of negotiating the issuance of a
high dividend rate preferred stock (9%) for a larger amount than the purchased
equity.
3.
The interest of investors appears to be
increasingly speculative. For example, in the five trading days ending Friday,
seven of the ten largest stocks in terms of dollars traded were ETFs. These included
two investing in the international developed markets, one in emerging markets,
one in smaller market caps, and gold as well as the leader, S&P500. The
other three stocks were Bank of America**, Citigroup** and JP Morgan**. With
the financial stocks as the best single sector last year, some may be
speculating that the three large banks will continue to be performance leaders.
(Rarely does the same sector lead two years in a row unless it comes from
severely depressed prior periods.)
Disclosures:
* Long
positions held in my private financial services fund
** Held
personally
The difference between
my leadership group and my potential acquisition targets is that I might add to
my leadership holdings if there is a serious market break, but I may even sell
if the targets’ prices drop as my patience could be worn out.
Please share with me
privately how you look at your portfolio.
_________________________________
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