Q1 2018 Performance

Q1 Performance

q1 2018

For the first quarter of 2018, my portfolio declined by 3.46%, and the S&P 500 dropped by 1.22%. My strategy still isn’t delivering any outperformance from when I started. I’ve discussed the reasons on this blog. I think a bulk of it is due to value investing’s underperformance as a strategy and specific errors that I’ve made with stock selection.

I believe the outperformance will come, but there is no way to tell when it will happen. It’s not something that you can time. I just have to stick to it and be patient.

Sentiment Shift

With that said, it feels like the sentiment is starting to shift in a way that might benefit value stocks.

For years now, the market has been rewarding cool, growth-oriented companies with higher and higher valuations. You know their names: Facebook, Apple (although Apple is odd in that it sometimes trades at a dirt cheap valuation), Amazon, Google, Netflix, Tesla, Nvidia. I would even lump cryptocurrency’s run into this bucket as an example of the sentiment.

Cool things rarely reward investors. Nearly all growth companies eventually run into problems that investors can’t anticipate or imagine. The higher their valuations (i.e., the higher the expectations), the harder they do fall once they run into the problem, which is inevitable. It appears that the stars of this bull market are simultaneously hitting those problems.

Tesla, for example, has been a star of this bull market. Its rise is due to a cool product and a popular CEO. The rapid rise in Tesla stock to absurd valuations gave Elon the currency to issue new shares and debt to keep the company afloat. Meanwhile, the company has never been profitable or generated significant cash flow. That sentiment appears to be shifting.

A friend of mine owned a Tesla and took me out for a ride in it once. It’s an impressive vehicle. The iPad instead of a console, the quick and silent acceleration. All of it is super cool. With that said, auto innovation is quickly commoditized. Think about it: your bottom of the line economy car (think about a Nissan Versa or a Toyota Yaris) has all of the features that a luxury car had in the ’90s. I’ve never been a “car guy.” For me, every car does 80 mph (which is all you can get away with on a highway) and has all the features I need. Why spend any more money than I need to? Tesla’s innovations are fresh and exciting, but in 10-20 years it’s just going to be standard. The big automakers are going to copy and compete away Tesla’s innovations. In the long run, it’s probably road kill. In the short run, the stock is at absurd valuations.

Facebook Is Bad For You

Facebook is running into problems as well. The problem which has been brewing for years is privacy concerns. Facebook presents its business model as a benevolent force aimed at “connecting humanity.” The reality is that it is an addictive product whose goal is to get people to turn over information about their lives, which Facebook then sells to advertisers. The perils of that business model came to a turning point in the recent scandal with Cambridge Analytica. I don’t know if the scandal will disrupt Facebook’s business model. As long as people continue to upload their life’s details to the site voluntarily, Facebook will have something that they can monetize. With that said, recent events do appear to be having an impact:

delete

I dropped my Facebook account a couple of years ago. Privacy was a part of it, but for the most part, I felt like Facebook was bad for me.

For me, I felt like Facebook was rotting my brain. That was the cost I was paying. The benefit was the connection with friends and family, but even that was entirely superficial. I also found myself wasting a lot of time on the app.

Regarding “brain rot,” a lot of it had to do with politics. The odd political opinions of my relatives and friends were making me dislike them. I thought to myself: did I become friends with these people because I agreed with their politics? Should a family member’s weird political opinions make me love them any less? The answer was, naturally, no.

Moreover, the bizarre beliefs I read on Facebook were hyperbole. The hyperbole on Facebook pollutes people’s outlook on the world. I also had to admit; the same thing was happening to me. I was confining myself to a shrinking bubble of information, and the increasing intensity of it all was polluting my mind. I found myself emotionally reacting to political posts instead of thinking critically about them.

The other odd thing I noticed was increased envy and jealousy. It’s unconscious, but it happens. No one posts their real life on Facebook. No one goes on Facebook and says “I had a huge fight with my husband today and I think he’s a jerk.” No one goes on Facebook and says “My children have so poorly behaved today that it makes me feel like I’m a bad parent.” No one goes on Facebook and says “My career feels like it hit a dead end and it makes me question my life choices.” However, these examples are all natural feelings that most people go through.

When you only see people post mostly “good” things about their lives, you start to think that your own life is inadequate, even though their life is probably as challenging and screwed up as your own. Think about it. Is life the happy pictures – the wedding albums, the graduation pictures, smiling families at events (the stuff that people put on Facebook) – or is it more nuanced than that? Every life has pain and disappointment. That’s not a bad thing – it’s just life.

People aren’t sharing their problems publicly on Facebook, but problems are still happening. We’re all human, and we all have issues. Social media makes us forget that and makes us feel inadequate.

I think more people are going to realize what I realized a couple of years ago. Facebook rots your brain and kills your self-esteem.

One of the most significant challenges in life is preventing your emotions from fooling you. Social media can make that an even more difficult task than it already is.

I digress. For growth stocks, the sentiment does appear to be shifting. We’ll see if it lasts.

Macro

Capture

The average investor allocation to equities

At the end of last year, the average investor allocation to equities in the United States was 43.787%. We are now beyond previous sentiment peaks, and current valuations had only been higher in 1998-2000. The 43.787% metric implies that in the next ten years we can expect returns of roughly 2.5%. The 10-year treasury yields 2.74%, so stocks no longer offer a premium over bonds.

The road to those returns is unknowable, but I think most investors are going to be disappointed in their returns over the next decade.

curve

The spread between the 10 year and 2-year treasury. When the 2 year has a higher yield than the 10 year (an inversion), it implies that monetary policy is too tight and will probably trigger a recession.

Concerning recession risk, the yield curve has not yet inverted, but it is in the process of flattening as the Fed raises rates. The lack of inversion means that a recession is unlikely over the next year. Eventually, however, the Fed’s tightening will cause a recession as it always does. The Fed is the cause and cure of every recession.

What this means for the short-term direction of equities is anyone’s guess. It does reduce the risk that equities will go down in a 2008-2009 style 50% drawdown. If the market does decline, it will probably be more like the 2000 decline. The economy was healthy, but valuations were absurd.

Of course, this bull run might just be getting started, and valuations may get even more insane. Over the short run, it is unpredictable, but we can infer from valuations that long-term returns will not meet investor’s expectations.

The Return of Volatility

After remaining dormant for a long time, volatility returned in force back in February. Volatility spiked, the market went down a little bit (10%), and everyone lost their minds. For people who were crazy enough to “short” volatility, they suffered a permanent loss of capital.

What’s funny about the whole ordeal was that the market decline was pretty tame and the rise in volatility was actually pretty normal in a historical context:

volatility

The return of volatility: angels and ministers of grace defend us

It was also really funny to me that so many tried to develop an explanation for the February decline. The reality is that there still isn’t agreement on what caused the crash of 1987! If we can’t fully understand what caused the crash of 1987, how can anyone say with authority what caused a 10% hiccup in February?

Everyone overreacted and lost their minds over a pretty normal event.

Volatility is your friend. Volatility is Mr. Market overreacting to events and losing his mind. You want to take advantage of Mr. Market, not be ruled by his mood swings. Too many investors fail to understand that the volatile nature of stocks is the reason that they offer opportunities to purchase mispriced assets.

If you can’t handle volatility – if you can’t handle very normal events like the one in February – then you don’t belong in the stock market. Bottom line, if you can’t afford to lose half of the money invested, it shouldn’t be in stocks.

Stocks are going to suffer a massive decline at some point. You can’t predict when that will happen, but I guarantee that in the next 10 years there will be multiple episodes when stocks suffer gut-wrenching declines. If you can’t handle them, then stay the hell away from the market.

It’s a good thing that most people can’t handle volatility and have no stomach for the gut punch that stocks frequently deliver. As long as most people are like this, Mr. Market will continue to offer attractive opportunities to people with the right emotional temperament.

My Portfolio

Below is a list of all of my open positions and the percentage change since I bought them:

list

Random musings:

  1. Retail: My retail stocks continue to weigh on my portfolio with the notable exceptions of Dick’s Sporting Goods and Foot Locker. Both companies delivered somewhat decent news, which was enough to deliver some solid gains. The two cheapest stocks in my portfolio (Francesca’s and Gamestop) continue to disappoint. Big Five isn’t doing quite as bad as those two, but it is still making me wince. Amusingly, Francesca and Gamestop are the two stocks that I am the most excited about. They are both priced for roadkill and any whiff of good news is going to send the stocks soaring (I hope).
  2. The international index ETFs I purchased for countries with low CAPE ratios are all doing very well and delivering solid performance. Russia and Singapore are doing the best, while Poland is the only one that is down.
  3. I didn’t do much this quarter. I did one trade, a small purchase in Argan. I had $1,000 in cash left from a distribution from Pendrell (odd lots were paid out when the company de-listed) along with some dividend payments. I decided to deploy it in Argan, which is an absurdly cheap stock with an enterprise value that is less than 1x its operating income. The timing was lucky, as the stock surged almost immediately after I bought it.
  4. Aflac was fairly volatile this quarter due to some lawsuits from former employees. The stock had a brief decline and then bounced back. It doesn’t seem to be a big deal and the stock continues to be one of the cheapest in the S&P 500.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

3 thoughts on “Q1 2018 Performance”

  1. I see a lot of ETF’s in your portfolio.
    Although the P/E’s of the ETF’s in your portfolio are lower than the P/E of the S&P500. Are you not afraid that the ETF’s take a great hit when the overall stock market takes a hit (with the high current valuations)?

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    1. I imagine that if the S&P is crushed, stocks globally will go down by the same percentage. The same can be said of all the stocks I own. My goal with the ETFs was to find a way to not concentrated too much in the retail sector, where I am finding most bargains in the US. Over time, I think a portfolio of bargain priced assets will beat the S&P.

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