Munger, Political Bile and Reading For Fun

How many different ways can I say that the market looks pretty expensive at these levels and a heightened sense of caution is warranted? My basic view of the stock market has not changed in the past week, and I do not expect it to over the next week. My trusty Barrons shows the market trading at 26 times earnings, and that’s not a fantastic starting point for a rally based on historical evidence. I could be wrong, and the Bulls could carry the day with the Trump inspired optimism winning the day. If I can find new safe and cheap ideas that pass my financial safety tests, I will buy them. I spend a good part of my day looking for stocks to buy but I am not finding anything right now. Hopefully, that changes soon, but I suspect it will take some sort of market dislocation to create some new inventory.

Of course, as much as the market loved President Trump the Democrats and the left hate him even more. There is a full court press going on in Washington, and it has created some political turmoil early in the new administration’s term. Trump and his team seem to be taking a page out of Andrew Jackson playbook and are counter punching, and all this just makes for some ugly politics. I confess that the vile mental regurgitations coming from both sides is hard to watch at times, but it probably gets worse before it gets better. I find the lack of independent thought and strict adherence to unproven dogma from both sides to be disturbing. The markets do not seem to care about the turmoil at this point, but that is subject to change without notice. Battles over tax reform and regulatory rollback could be upsetting if it doesn’t all proceed as smoothly as bulls are hoping.

Charlie Munger had some advice for Mr. Trump’s opponents at yesterday’s Daily Journal meeting he said that “Trump is not wrong on everything. Just because he isn’t like us, roll with it. And if there is a little danger, what the hell, you’re not going to live forever anyway.” He added that “I always try and think about the good along with what’s not good. I think some of this stuff where they’re re-examining options about the whole tax system of the country, I think that is a very constructive thing.” Mr. Munger also had some thoughts on all the protestors and boycotts saying “I don’t like all that. Basically, I’m not in favor of young people agitating and trying to change the whole world because they know so much. I think young people should learn more and shop less, so I’m not sympathetic to anybody. Young people are out in the streets agitating—that’s not my system. I think if you’ve got Hitler or something you can agitate. But short of that, young people should learn more and shop less.”

He added “You can get so consumed by some kind of ideological notion (particularly at a left-wing university) that you think you are handling ethics and what you’re doing is not working and maybe smoking a little pot to boot. This is not the Munger system. My hero is Maimonides. All that philosophy, all that writing he did after working all those hours a day as a practicing physician all his life. He believed in the engaged life. I recommend that you engage life. If you spend all your time on how some politician wants it this way or that way and you’re sure you know what’s right – you’re on the wrong track. You want to do something every day where you’re coping with reality. You want to be more like Maimonides and less like Bernie Sanders.”

Investors would do well to follow not just Mr. Mungers words but his actions as well. Once again this quarter the 13F filing from the Daily Journal, where he is the chairman, showed no activity. It has not shown any activity since 2009 when Mr. Munger took the firms cash and bout four stocks as the markets were collapsing. He has not traded around the positions and “managed the portfolio in any way. He has just sat still and watched his money multiply by several multiples of his purchase price. Sit on your butt investing at its finest.

Speaking of 13F filings, I am apparently not the only one concerned about market levels. I saw a lot of selling in 13F filings this week from leading value and activist investors. There was even a good deal of selling among the bank stock specialists as valuation blossomed post-election, something I haven’t seen in a long time. It was not just the bank guys either as value types, and private equity firms were also doing a lot of selling and very little buying in the fourth quarter. This is just another caution flag about market levels and valuations, and you ignore it at your peril. I am not selling anything that I have yet, but I am very reluctant to be a buyer at these levels.

Onto to happier thoughts position players report in Sarasota today as the Orioles get ready for the new season. I like our chances if Bundy and Gausman pitch to potential and Tillman comes back healthy. We are going to have a tough year with Boston loaded with talent and New York adding youth and power to the lineup, but we have the bats to compete. Our bullpen looks good again. Buck Showalter was asked if this was the best bullpen he ever managed and he said “This would rank right up there potentially because of the depth of it and the ability for Brad and Zach and Darren and if Mychal can duplicate what he did the last month of the season. The difference is all four of them can get left- and right-handed hitters out. That’s what’s unusual about it. They’ve got an inning, they pitch it. You’ve got four hitters, and three of them are right-handed, you don’t have to get a guy up as soon as somebody gets on base. That’s how you keep bullpens healthy.” If we can add competitive starting pitching to bats and bullpen, we will be in the hunt.

On the all-important recreational reading front, I blitzed through the first three books in the Jim and Kram Mystery series by Brent Purvis. Nothing educational in these other than a little history and geography of Southeast Alaska but they are a fun read. Pure escapism, which may be increasingly needed as the political environment just gets weirder in the weeks and months ahead. Parts are laugh out loud funny, and all three have a decent plot. There is a new addition to the Miami Jones series out this week as well as new Charlie Crawford Palm Beach mystery. I am a fan of both of those series and am looking forward to consuming them soon.

Every once in a while I get an email complaining about my discussion of books and baseball and advising me to stock to the market. That doesn’t sound like much fun to me, so I usually send a polite thank you and ignore the suggestion. I am also asked why I don’t offer suggestions for more serious book. While I read a lot of nonfiction and have been known to dabble in philosophy, there are more than enough people doing that. Shane Parrish at the Farnam Street Blog does a fantastic job of this. Patrick O’Shaughnessy does a phenomenal job with his book club. Yu don’t need me to do that. Lots of other folks are doing that for you. I do a lot of serious reading, but I also read for the pure fun of reading, so I like to share some of the books I found fun to read

Also, most of us would be better off spending more time reading fiction and watching baseball than we do reading about chart patterns, formulas and astrological events that will help us make money in the stock market. Buying right and holding on over time is going to make you more money that all of that stuff. Patiently owning stocks bought at a discount price while watching baseball games and reading a good book is going to make you more money that all the lines you draw on charts over your investing lifetime.

That’s all for this week. I’m stopping by the American Association meeting here in Orlando nest week, so I am sure I will have some interesting tidbits from that gathering next week. Plus there actual baseball games on Thursday and Friday!

Cheers,
Tim
For baseball fans it is time for some

Big Guns, Cheap Banks and Sweet Cash

It seems the hedge fund gurus are out in force of late talking about their view of the market. Ray Dalio of Bridgewater penned a piece in a recent edition of The Economist, and he was less than upbeat, to say the least. He wrote “The bond market is risky now and will get more so. Rarely do investors encounter a market that is so clearly overvalued and also so close to its clearly defined limits, as there is a limit to how low negative bond yields can go. Bonds will become a very bad deal as ­central banks try to push more money into them, and savers will decide to keep that money elsewhere. Right now, while a number of riskier assets look like good value compared with bonds and cash, they are not cheap given their risks. They all have low returns with typical volatility, and as people buy them, their reward-to-risk ratio will worsen. This will create a growing risk that savers will seek to escape financial assets and shift to gold and similar non-monetary preserves of wealth, especially as social and political ­tensions intensify.”

He added, “For those interested in studying analogous periods, I recommend looking at 1935-45, after the 1929-32 stock market and economic crashes, and following the great quantitative easings that caused stock prices and economic activity to rebound and led to “pushing on a string” in 1935. That was the last time that the global configuration of fund­amentals was broadly similar to what it is today.”

Being me, I went and looked. Driven by stimulus programs the market had risen from the bottom in 1932 through 1935 and continued to move higher until topping out in 1937. From here we fell by about 50% before bottoming. We didn’t recover the 1937 highs until 1945. Mr. Dalio doesn’t think a collapse is imminent but warns that the buying of risk assets by investors chasing return will continue to make them less attractive until the bubble does pop so to speak and a pullback in stocks and bonds become almost inevitable.

In a very rare occurrence, the whole of Seth Klarman’s annual shareholder letter was leaked, and he was not much more upbeat about things. He wrote to his investors saying “The steady drum beat of stock market gains (the S&P 500 index closed at record highs on eight different occasions between the election and year-end) casts a spell on market participants -no one wants to miss this ticket to paradise. As they piled in, investors were largely ignoring perilously high valuations. Goldman Sachs noted that the S&R 500, in aggregate, recently traded at the 85th percentile of its historical valuation over the last 40 years, while the median company in the S&P 500 had reached the 98th percentile of valuation. Respected investor Jeremy Grantham calculated this market as the third most expensive of the last century, behind only the markets of 1929 and 200, both of which ended disastrously for investors. David Rosenberg, the respected chief economist and strategist at Gluskin Sheff, a leading Canadian asset manager, noted that the U.S. stock market in early December was pricing in a whopping 30% earnings per share growth for 2017.”

David Einhorn of Greenlight Capital warns that we may see a reversal of the Main Street Wall Street disconnect at long last. He told his investors that “Since Election Day, the market appears to have changed its macroeconomic outlook and is re-evaluating the prospects for many companies accordingly. This change in tone has been favorable to our style, and we generated a good result in the quarter despite our low net exposure and a decline in gold. Rather than look backward, we’d like to share our views of what a Trump Presidency (TP) might look like and why we believe we are well-positioned for 2017. In short, we believe that the post-Great Recession easy money policies have been good for Wall Street but bad for Main Street. It’s possible that the TP reverses these policies, which would be good for Main Street but rough on Wall Street.”

He suggests that one of the strategies to prepare for a Trump Presidency is to short a basket of bubbles. He suggested “Bubble basket stocks mostly don’t have profits, which makes them unlikely to benefit from corporate tax cuts. Further, an accelerating economy should allow investors to find growth without needing to pay nosebleed prices for a narrow group of profitless top-line growth stocks. We think the basket is poised to further underperform with one caveat: There is a risk that Disney decides to star in the Internet Bubble 2.0 remake of the TWX/AOL deal by acquiring a profitless Netflix (NFLX) at the top. We suspect Disney won’t. Accordingly, NFLX merits a spot in the basket because its domestic market has matured; it risks an unfavorable change in net neutrality rules, and it has not demonstrated that its huge investment in original content has a positive return. We believe it doesn’t. NFLX is able to report that its U.S. streaming segment is highly profitable only by allocating a disproportionate amount of content amortization to its smaller and unprofitable international streaming segment.”

Daniel Loeb of Third Point reminded us that this is not the 1980s. He wrote to his investors saying “While markets are at highs, accelerating economic growth both in the U.S. and globally means that earnings should also rise for the first time in three years. The combination of higher nominal growth and lower tax rates could cause earnings to rise in the high single digits this year. Some observers highlight the parallels to the 1980s, but drawing too much from that comparison is dangerous because the starting levels are very different. Then, both interest rates and unemployment were high; now, both are low and likely moving higher. Debt as a function of GDP was 30%. It is now 80%. The median age in the U.S. was 30 then and is now 38. While this does not mean things cannot improve, particularly in 2017‐18, creating a virtuous cycle by following a 1980s blueprint is highly unlikely.

Mr. Loeb does make me happy with his thoughts on financial stocks, of which obviously we own a ton. He is quite bullish saying “In terms of fundamentals, rising rates in the U.S. have the obvious benefit of boosting net interest margins. But this is particularly true today because banks are sitting on more excess cash and liquidity than at any time in history. Indeed, with over $4 trillion of liquidity parked at the Fed, many banks do not need additional deposit inflows to fund loan growth for years to come – they already have the cash on hand to lend. This amplifies the benefits of rising rates as banks raise lending rates without a corresponding hike in deposit rates.” He further notes that “Our bank stocks trade at less than 10x earnings with high‐teens EPS growth ahead and at a small premium to tangible book value for returns that will expand into the mid‐teens.”

 

I don’t base my investments decisions on what the big guys are doing. However, the actions and opinions of investors who have made a lot of money over a very long time are certainly input factors into the decision making process. The limited number of safe and cheap opportunities is also a great reason for caution at current levels. I think that anyone willing to throw caution to the wind in what is a pricey market surrounded by uncertain conditions is being foolish. The market has been moving up for eight years now pretty much without a break in spite of a slow growth environment buoyed primarily by low interest rates. That may be changing, and I think that I grow fonder of my cash hoard with each passing day.

 

Moving onto more important things pitchers and catchers begin reporting on Monday and position players should all be in camp by the end of the week except the slackers on the Texas Rangers. Their position guys don’t show up until a week from Monday. I have started the data collection process for my season preview which is usually out sometime in mid to late March. I see that my wife has us heading out to the beach in Texas to visit her family in late March so I expect that’s when I will do it this year as the idea of combining baseball and beaches has a certain appeal. My track record predicting baseball seasons has been much better than my record predicting stock market movements. It is shaping up to be a very interesting season, and my Orioles look to be in it all year. I am signing up for my MLB TV package so if you see me walking along staring at my phone over the next eight months its not social media; it’s baseball!

Have a great week.

Cheers!
Tim
When approaching markets its probably best to emulate Bob Marley and use some

Skinny Tigers, Hot Rods and Talented Armadillos

I didn’t get a Thursday piece out last week as I was busy prepping for my trip to Phoenix and the Bank Directors Acquire or be Acquired Conference. This is easily my favorite conference each year as more than 1000 bankers, investment bankers, and Fintech types gather in the desert to talk banking. The mood this year was incredibly upbeat as bankers are looking forward to reduced regulatory requirements, lower taxes, higher interest rates and a stronger economy. I am not sure they will get it all as quick as they would like but as I quickly discovered mentioning that fact to a banker who is blinking in the sunshine as they emerge from almost nine years in the darkness is a lot like trying to take a steak from a skinny Tiger.

I confirmed again on this year’s trip that my backside is not built for any flights much over 4 hours. Airlines are maximizing profit by squeezing as many folks on each flight as they possibly can, and that makes for uncomfortable flying. Of course, I am old enough to remember when you were served an entire meal on a flight and could sit back and enjoy a cigarette after the meal. Times have changed, and while I appreciate the profit motive, my skinny butt does not enjoy the long voyage in an uncomfortable seat. As I was picking up a rental car when landing, I could not even use the cocktail remedy to solve my comfort issues, so the last hour or so of the flight was just not fun.

The rental car was fun. They gave me a Dodge Charger Hemi to drive, and I am not a car guy by any stretch of the imagination, but that thing is just fun to drive. It growls when you step on the gas and takes off like the guy who took the steak from the skinny tiger. I could never own one of these cars. I would have to get a real job just to pay off the traffic tickets that would quickly accumulate.

Back to the conference, there was a great deal of optimism about deal activity this year. The Trump Bump has lifted valuations, and that helps deal activity in two ways. First, those banks who are interested in acquiring now have a much stronger currency to use to get deals done. Second, smaller banks that have resisted selling because they could not get the price they wanted are now a lot closer to a price they can be comfortable accepting. There are still a lot of tired bankers out there, and they have wanted out for some time. The average bank executive is over 60, and the average board member is over 70, and after eight tough years, they are, ready to call it today and work on their golf game or sit under the palm trees with umbrella drinks. The figure tossed around the most was that 4 to 5% of community banks would be acquired this year which would work out to between 24o and 300 deals in 2017. We have already seen one deal in our portfolio as it was announced that Royal Bancshares of Pennsylvania (RBAA) was being taken over on the second day of the conference. I expect to see a lot more before we close the books on 2017.

The best session for my money was the Investors panel of Tom Brown CEO at Second Curve Capital, John Eggemeyer Founder and Managing Partner at Castle Creek Capital, Richard Hunt President & CEO at Consumer Bankers Association and Josh Siegel Chairman and CEO at StoneCastle Partners, LLC. These guys weren’t just bullish they were wildly so. They did agree that most of the deal activity will once again be among the smaller banks with less than $1 billion in assets, but they felt, the larger banks would see enormous benefits from the improving outlook for banks. Their only concerns seemed to be management that did something stupid or failed to keep up with technology. Using FinTech to improve profits as well as attract and retain customers was seen as critical by nearly all the panelists. The panel seemed to feel that headwinds were turning into tailwinds for the whole sector. The tide is just turning so there are not any excesses in the system, credit is solid, and the road is clear for banks to have an extended run. These are very smart investors with decades of experience investing in community banks so when they are bullish, perhaps we should pay attention

This is also the year that banks and FinTechs did a Tracey –Hepburn and quit quarreling long enough to realize they were madly in love. Fintech has realized that they are not going to replace banks without actually becoming banks themselves and banks have come to understand that the nerdy kids in board shorts with broken glasses and a laptop with enough power to run a mission to Mars can make them more efficient and more profitable. The talk has shifted from protecting themselves from Fintech to how to best partner with them for fun and profit. There is even growing chatter from banks about just taking over a FinTech company that has the technology they want to use to run their banks.

Bank Director did an instant survey of the audience, and the data was interesting. 44.7% of bankers felt that M&A remained the best way to grow their bank. 27.5% thought they would be able to use both M&A and organic growth to get bigger in 2017. 48.5% of bankers in attendance expect to buy another bank this year. 60.4% think we will see more deals this year than we did in 2016. Market location and deposit base were the key considerations when looking at a target for the bankers in the room. 78.7% think that the new administration is great news for banks.

Most of the time I never even use the word diversity. I am a free market type with an unwavering belief in the power of the meritocracy. The job should fall to the best person regardless of race, genitalia, dating preference or species. If a gay Hispanic armadillo best for the job at hand that’s where the job should go. However, each year when I go to this event I come away with a sure and certain knowledge that in the executive suite community banks have a serious diversity issue. There is none. Almost the entire audience was middle-aged and up white men. Given that John Eggemeyer of Castle Creek pointed out that banking does suffer from a dearth of management and the industry struggles to attract talent it seems silly to me to limit membership in the club. If I were at the ABA or ICBA (Independent Community Bankers Association) job, one would be working with universities around the nation to attract women and minorities to the banking industry. The industry needs to begin looking more like the market, and right now we are a long way from that being true.

We are only 16 days away from pitchers and catchers reporting to camp here in Florida and out in Arizona. Out long national nightmare will, at last, be over and baseball will be back in America. We can turn our weary eyes away from politics and once again focus on the things that matter in life like the fate of the Orioles young pitching staff and the Cubs chances to repeat. The focus will shift from Trump to Trout, and we all will be better for it.

Have a great week everyone!

Tim

Much like my Hemi in Phoenix this week bans and bank stocks look to be ready to