Stephen Takacsy on BNN-Bloomberg’s Market Call – Jan 28,2019

Stephen Takacsy on BNN-Bloomberg’s Market Call – Jan 28,2019

MARKET OUTLOOK

A year ago, we warned viewers that various speculative manias such as cannabis stocks, cryptocurrencies and blockchain were signs of a market top. Towards the end of 2018, we finally saw a massive sell-off in equity markets led by the U.S. The American stock market was disconnected from global markets which were already struggling and it was grossly overvalued, mainly led by a small group of tech stocks. Rising interest rates, a strong U.S. dollar and U.S. trade wars started having an impact on U.S. corporations, as 44 per cent of S&P companies derive their revenues from foreign markets that were slowing down.

The pull-back in equity prices was amplified by computer-driven algorithmic program selling, high-frequency trading, momentum strategies, quantitative models, the liquidation of several large hedge funds, and the indiscriminate selling of baskets of stocks held in ETFs triggered by panicky and leveraged retail investors as well as tax loss selling. It’s estimated that 85 per cent of trading volume had nothing to do with actual company fundamentals, a fact borne out by the equally rapid rebound in stock prices being experienced by global equity markets thus far in 2019. The “the herd effect” has only gotten bigger with the growth in automated trading and ETFs, leading to more pronounced periods of over and undervaluation.

This suggests that markets are becoming less efficient, creating better opportunities for active portfolio managers going forward. While valuations have come down to more attractive levels, given the ongoing economic and geopolitical uncertainties, equity markets are likely to remain volatile. We continue to be very selective and generally stick to defensive stocks with low exposure to cyclical or economically sensitive sectors relative to the market

TOP PICKS

Market Call Top Picks

VELAN (VLN.TO)
Long-term core holding.

Velan is a world-leading manufacturer of complex industrial and nuclear valves with sales of half a billion dollars. The stock is down 50 per cent over the past year due to lower profitability. Backlog is growing and management is focused on improving margins by cutting costs, closing money-losing plants (they just announced la major plant closure in Montreal last week), optimizing their global supply chain and selling higher-value-added products. Stock is trading at under $10 while book value is around $19.

We believe that if sold to a strategic player, the company would be worth between 1.3 times and 1.5 times book value per share or $25 to $30. We purchased more shares at around $9.

NFI GROUP (NFI.TO)
New position.

NFI is one of three major manufacturers of transit buses and motor coaches in North America. The stock is down over 40 per cent in the past few months and yet company released record profits. Backlog is strong and margins are steady with little impact from tariffs. NFI is also a leader in electric buses. The company generates strong free cash flow and is recession-proof due largely to bus replacement cycle. NFI trades at under nine times price-to-earnings and pays a 4.5 per cent dividend. The company has been buying back massive amounts of shares and we expect it to continue growing earnings per share and the stock to move back into $50s.

SIENNA SENIOR LIVING (SIA.TO)
Core holding.

Sienna owns over 100 long-term care facilities and retirement homes in Ontario and B.C. It’s the second-largest publicly traded retirement residence owner after Chartwell. The company has great defensive characteristics in this volatile market. The dividend yield is currently 5.3 per cent. Rising interest rates shouldn’t impact this stock, as rental leases are short-term in nature and can be adjusted for inflation. It should be steadily increasing its net operating income and adjusted funds from operations per share and growing dividends over the long run. It was added to TSX Composite Index last year.

Stephen Takacsy, Lester Asset Management

Martin Whitman: Focus on the Balance Sheet

Martin Whitman: Focus on the Balance Sheet

POSTED MARCH 6, 2013 JOHN HUBER

I spent the weekend in a cabin in the Catskill Mountains in New York. In between hikes I spent a lot of time by the fire reading old shareholder letters by Martin Whitman of Third Avenue Management. Whitman is a legendary value investor, and his letters are an incredible source of learning about general value investment principles. It’s also a great opportunity (as other fund manager letters are) to see what individual stocks they are invested in, and more importantly, the logic they used in making those investments. Reverse engineering some of the best investors’ ideas is an invaluable way to learn.

I read through a few of his letters over the weekend, and later this year I plan to study each one that is available on his website, and I’ll make short comments about them here on the blog as I go through them.

One of the things I like about Whitman is that he is a balance sheet guy. What I mean by this is he is more focused on a company’s net worth (book value), than he is about earning power. Earning power is extremely important, and Whitman acknowledges that you need to weight both the income statement along with the balance sheet, but he says that most investors would benefit if they focused more attention on the assets and liabilities a company has, along with management’s ability to grow the company’s net asset values.

He mentions how Wall Street values earnings over everything else, but the rest of the business world first looks to net asset values (or other balance sheet metrics). He talks about how the first thing Warren Buffett discusses each year in his shareholder letter is Berkshire’s change in book value. He mentions how most businessmen are concerned with wealth creation, or growing their net worth or the net worth of their businesses. Mutual funds report their change in NAV, etc…

This is very much in the school of classical Graham and Dodd, who were much more concerned with identifying a company’s assets, and using balance sheet analysis to determine whether they had a margin of safety. Their strategy worked incredibly well, providing 20% annual returns over the course of 3 decades. A recent study by Tobias Carlisle (author of the great blog Greenbackd): 75 Years and Outperforming-Graham Strategy analyzes the results of a hypothetical strategy that invests in a portfolio of all the stocks selling for less than 2/3rds of their net current assets (defined as current assets less total liabilities). Basically, Graham was looking for stocks that were selling for 67% of liquidation value.

The results are absolutely stunning: the hypothetical portfolio of these so-called “net-net” stocks, many of which had no earnings at all, produced a shocking 35.2% annual return for the period from 1984-2008. A predecessor study showed similar results (29% annual returns) from 1970-1983.

Whitman mentioned in something I read that he felt individual investors (he calls them Outside Passive Minority Investors, or OPMI’s) could significantly improve their results by focusing more attention on what stocks are truly worth, and worry less about the future earnings potential, which is much more difficult to predict.

Whitman’s thoughts are similar to Ben Graham and Walter Schloss, two of the investors that have had the largest impact on my own investment ideas. I personally place a lot of emphasis on earnings, but the balance sheet is the foundation and is given top priority in my book.

I’ll be talking more about Whitman as I study his letters and ideas. Lots to learn on his site…

Resources,

http://basehitinvesting.com/martin-whitman-focus-on-the-balance-sheet/

New Management and Corporate Restructuring

New Management and Corporate Restructuring

One of my core investing themes has always been ‘Wager Value’…Borrowing from one of my earlier blog posts, I describes it as follows…

‘Back in the eighties I use to go to the racetrack to bet on Thoroughbred Racehorses. It was a good training ground for investing in the stock market. I came across a term by handicapping author, James Cramer. He called it Wager Value.  Essentially it meant focusing on information that other handicappers aren’t using. Whereas most people who went to the track used speed ratings and the horse’s current form shown in the past performance tables, Cramer like Stephen Davidowitz before him focused on trainer patterns, track bias and result charts. He reasoned that if he based his handicapping (estimating probabilities) on underused information, the horses he would come up with would help provide him with more attractive odds. So he might estimate a horse’s chances of winning to be 3-1 while the tote board (based on everybody else opinion) would have the same horse going off at 8-1. This is the very heart of handicapping a horse race, betting on the horse who has the best chance of winning relative to his odds.’

Likewise, when investing in the stock market, it pays to focus on information that most other people are not paying attention too. Over the years I’ve found that following up on new management teams that are in the process of restructuring their new company can be a potent ‘handicapping angle’ to use when looking to generate new investing ideas. Often these types of companies are under-performing so are more or less ignored by the mainstream investing public. It is also a good idea to check where the 'new management' came from and their track record while there.

Without getting into the specifics…what follows is a short list of interesting investing ideas where this idea currently applies.

Rogers Sugar Inc.

RSI on the TSX

Baylin Technologies Inc.

BYL on the TSX

ATS Automation Tooling Systems Inc.

ATA on the TSX

Velan Inc
VLN on theTSX

Centric Health
CHH on the TSX

GrafTech International LTD.

EAF on the NYSE

For my own frame of reference of course...

The Emperor has no Clothes

The Emperor has no Clothes

There is a fairy tale called "The Emperor's New Clothes." In the story the Emperor is a vain man and always wants the newest fashions. A couple of swindlers convince him that the clothes they are making him are of such fine quality that only the most sophisticated people can see them. He can't admit that he's not the most elevated person, so he wears the clothes in the palace, and everyone bows down and says what a fine set of clothes he has because they are afraid to contradict the Emperor. Then he goes out and leads a parade to show off his new clothes to the people. Everyone pretends to admire the clothes except one little boy who yells out "But the Emperor has no clothes.

If enough people believe in something it becomes a thoughtform, something we create out of our own minds and the more people who participate in believing this thoughtform the more powerful it becomes until it is accepted as material reality. Only problem is it is not reality but a belief about what reality really is….welcome to planet earth, world of many thoughtforms like religion, politics and yes the stock market as well.

Now the stock market has many sub-divisions of thoughtforms that live within it. Most of the people investing in the market can’t see the forest for the trees so they get caught up in believing these various thoughtforms….examples of these various thoughtforms would be…you can’t beat the market, big caps are safer, its dangerous to invest by yourself, passive investing is the only safe way to invest, you will need financial advisors to help you, you have to own the big Canadian banks, small caps are dangerous, you have to diversify, you have to invest outside the country you live in…the list goes on and on and some of these thoughtforms may even be true…for some people. The problem is everybody is different but the ‘swindlers’ in our fable above want to put everybody in their own personal box where they can be manipulated and controlled and ultimately used.

The moral of the story is if you are going to be successful in investing in the stock market, you are going to have to think for yourself. When you think about it, all progress that was ever made in this world was accomplished by people who didn’t believe the accepted view (thoughtforms).

Ten Day Oscillator and Impulse Waves

Ten Day Oscillator and Impulse Waves

I first came across this idea in Justin Mamis’s book ‘The Nature of Risk.’ In the chapter titled ‘What the Market Says II’, Justin introduces the reader to the ten day moving average of the net differential between advances and declines. Now the NYSE no longer reports advances and declines based on common stock data only (operational companies) but the indicator works equally as well for advancing volume and declining volume, so that’s what I use to track the indicator.

It basically works as a short-term overbought/oversold oscillator so it measures momentum extremes in the underlying market on a short term basis. Having said that, whenever the market has a severe sell-off that drops the indicator to an extremely oversold condition, Mamis warns the reader to be an the lookout for a turnaround impulse wave up that takes the indicator to an extreme overbought state…this is an excellent tip-off that the market will stage a strong rally off the bottom. The pullbacks that come up will tend to be shallow with strength returning to a market surging upwards.

Well fans, this is happening right now and I’m not the only person to notice this. Please read the link below from Jeffrey Saut who discusses the same phenomenon on his morning tack…

https://www.raymondjames.com/pdfs/share/morning_tack.pdf

Now making forecasts or trying to predict what the market will do in the future is almost always a mistake but we as investors can still take the market's temperature and in so doing gauge the amount of risk that is currently in the market...So bearing what has been discussed here in mind, the risk level of being in the market appears low when compared to the potential rewards.

Taking the Market’s Temperature

Taking the Market’s Temperature

Howard Marks has often written about the importance of taking the market’s temperature in order to get a sense of where it is in its cyclic process. He suggests investors avoid trying to make predictions about the markets. I agree making predictions or listening to the forecasts of others is pointless. To borrow an idea from metaphysics it’s important to focus on the “now”, to stay in the current moment and focus on what is happening in front of you. In other words, what is the market doing now and where is it within its own cyclic rhythm.

I cut my teeth on technical analysis in the first 15 years or so of studying the markets. I eventually decided I was better served by focusing on the individual fundamentals of the companies I was investigating. However I found technical analysis very useful in studying the breadth of the market. To do this I track the advancing/declining volume and the New High/Low index of the NYSE. I make a running total of the difference of the adv/dec volume and cumulate it over time. I then keep a couple moving averages (19 day and 39 day)  of that cumulative total. I subtract the longer moving average from the shorter one. This creates a trend deviation indicator which tracks the intermediate momentum of the cumulative adv/dec line (based on the volume of the NYSE.)

I also keep track of a short term oscillator (10 day moving average of the difference between the daily adv vol and dec vol).

The short term oscillator made a deep low in late December while intermediate term momentum made a deep low the last few trading days. This is an important market reference point. If this low holds, the market will likely start to build a bottom over the next few weeks/months. If this low is violated, more market weakness should ensue. Based on the history of these indicators I think the low is in and a bottoming process will now ensue over the next little while. Late December seemed to be the point of capitulation where people gave up and just sold into a vacuum of buyers.

That is the current context of the overall market. Pessimism is everywhere. Remember the Speculator’s Edge…to Demand Supply and Supply Demand. There is a lot of quality merchandise out there going at good prices. This is an opportunity to buy low. 

Knowing things like this can give an investor a sense of perspective he will never realize if he just gets his information from the media who are just there to confuse and over-hype the news of the day causing confusion and worry.