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Blue Tower Asset Management 1Q20 Commentary: The paradox of value investing

Blue Tower Asset Management 1Q20 Commentary: The paradox of value investing

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4 years ago

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Federal Open Market Committee International Monetary Fund Monetary Policy Committee U.S. Federal Reserve G7 Finance Ministers the World Bank Coronavirus COVID-19 FOMC

Blue Tower Asset Management commentary for the first quarter ended March 31, 2020, discussing value stocks continue to trail growth stocks, the spread of the Covid-19 disease, Fed’s loans to repo markets and USD exchange rate fluctuations.

[klamran]

Q1 2020 hedge fund letters, conferences and more

Blue Tower Asset Management loans to repo markets

There are rare times when one feels that they are witnessing history being made as the world we knew quickly transforms itself into something totally unfamiliar, and the current situation certainly feels as one of those times.

The two most salient features of the current bear market were the sheer speed with which the economy declined, with the S&P 500 falling 33.9% from February 21st to March 23rd and the accompanying extreme volatility of the markets. Following this decline, the S&P 500 proceeded to have a gain of 24.8% over the next three weeks. The S&P 500 saw three consecutive days of percentile changes greater than 9%, an event that had not been observed since 1929. On March 16th, the CBOE Volatility Index reached 82.69, eclipsing 2008 for the highest closing level ever.

The decline in economic activity and some of the stresses visible in financial markets exceeds what was seen in the first months of the 2008 global financial crisis. US Treasuries are among the most liquid markets in the world. However, at one point in March, the bid-ask spread for off-the-run 10-year US Treasury notes was as high as 50 basis points. For some of our lower-volume Japanese securities, the illiquidity reached extremes we have never seen before with bid-ask spreads in some cases expanding to over 20% of the share price.

While we were aware of the Covid-19 virus in January, we did not anticipate the level of economically disruptive policy response we have seen which far exceeds other deadly viral pandemics in the recent past such as the influenza pandemics of 1957 or 1968 which both killed over a million people globally. This current turmoil is not due purely to the direct effects of the virus. The world is also facing a rapid collapse in oil prices, significant geopolitical tensions, and high corporate leverage ratios (US corporate debt has increased from $6.2 trillion, 42% of GDP, at the end of 2009 to $10.1 trillion, 47% of GDP, at the end of 2019).

The Blue Tower Global Value strategy declined by 31.97% net (31.78% gross) in the first quarter of 2020. This quarter’s performance, our worst on an absolute and relative basis, follows Q4 2019, our best quarter performance. Quarterly results are not particularly meaningful as our performance should be judged over multi-year periods. Our long-term performance will reflect the quality and value of our portfolio.

At the beginning of this quarter, over 75% of our portfolio was comprised of small-caps and a majority of the portfolio was invested outside of the US. So far this year, low-volume small-cap stocks, value stocks, and international companies have sold off far more than the overall US stock market. The Russell 2000 value index ended the quarter down 35.7%, its worst quarterly return in history (also the worst quarter for the overall Russell 2000 index). The relatively lower volumes of small-cap securities may have accelerated their decline due to the forced liquidations occurring in the present market. While the value factor has outperformed over the long-term, its outperformance has always been cyclical. During the recovery phase of a financial crisis, small cap value has tended to outperform the overall market.

Value Continues to Trail Growth

One of the paradoxes of value investing is that it offers its best prospective returns when its recent trailing returns makes it the least persuasive as an investing approach.

In many ways, it seems like rational pricing has disappeared from equity markets. Our portfolio has been no exception to this. Joban Kaihatsu (Tokyo:1782), a profitable dividend-paying company in our portfolio, ended Q1 at a share price of 4670¥ despite holding 5843¥ per share of cash net of debt and having a portfolio of marketable securities that at the end of December 2019 was worth 1793¥ per share. It is hard to believe a profitable company is worth less than the cash in their bank and brokerage accounts. Many of our other holdings have also been buffeted by large irrational price moves.

Price paid for investments is in most cases the most important determinant of future returns and at these prices, value appears to offer some of the best prospective future relative returns in its history.

While this year will be anything but normal, we estimate that our current portfolio at April 10th prices under normalized circumstances would offer a free-cash-flow yield of 18 to 19%. This is the highest prospective FCF yield we have ever estimated for our portfolio.

Blue Tower Asset Management loans to repo markets

Covid-19 Crisis Potential Outcomes

The most important determinant of investment returns in 2020 will be the spread of the Covid-19 disease and the policy actions taken to counter it. The uncertainty in both of these is a root cause of the volatility we have been seeing this year. Additionally, there are unknowns of the long-term health effects of Covid-19 infection, the number of asymptomatic patients, and the efficacy of current candidate therapeutics to treat the disease.

As I expect that most people have consumed vast amounts of information on the current coronavirus pandemic, I will keep discussion of the virus itself brief. The optimistic view is that this virus will have a death toll similar to the seasonal flu with a higher basic reproduction number (a measure of contagiousness) and shorter epidemiological profile. Severe cases may suffer permanent lung damage or fibrosis, but the vast majority of the infected will make full recoveries. The more pessimistic views are for large percentages of the world to be infected with a death toll an order of magnitude higher than the flu and many of the survivors having considerable disabilities. WHO Director-General Tedros Adhanom estimated a case fatality rate of 3.4% for Covid-19
1 and the most pessimistic estimates from epidemiologists of potential global population infection rates range from between 60 to 80%.

This crisis, the government-mandated lockdowns, and individuals engaging in protective sequestrations of themselves and their families will all have extreme effects on the reported financials of businesses. As long as companies are able to weather this storm without dilutive financing or bankruptcy, the long-term effect on their prospects should be minimal. Equity investors will likely ignore the reported results of 2020 and focus on the long-term prospects of companies in their valuations with the expected loss from this year being removed from their normalized model of the company’s enterprise value.

While some of our portfolio positions will have their 2020 earnings impacted, this one-year hit to earnings does not dramatically change their future earnings ability.

USD Cash Crunch

The current crisis has caused a massive drive for US dollars causing large fluctuations in exchange rates and appreciation of the dollar against a basket of foreign currencies. The US dollar has become a global currency despite its issuance being firmly under the control of the US Federal Reserve. Roughly, half of global trade is invoiced in dollars and foreign nonfinancial corporations collectively have issued $12.1 trillion of US-denominated debt2. At the same time leveraged investors facing decreasing security prices and large asset managers facing redemptions have been forced into liquidating their positions in order to meet their liquidity needs.

Foreign corporations with dollar-denominated debt are in essence short the dollar as their domestic markets provide them with local currency. In order to get the dollars that these companies need to meet their dollar financial liabilities, they need to sell their products and services into the international market. When there is a demand shock and decrease in global trade as was created by this viral pandemic, their supply of dollars from serving customers dries up. They must therefore liquidate their domestic holdings or exchange domestic cash reserves for US dollars to meet bond interest payments and other dollar liabilities which do not get put on hold despite their business slowdown. All of these companies going for dollars at the same time causes this drive for dollar liquidity. The Federal Reserve has engaged in several interventions aimed at stabilizing the value of the dollar in the midst of the current crisis.

US Government Programs: Loans To Repo Markets

The US Government has engaged in monetary and economic interventions at a level never before seen in history. These include loans to repo markets, special grant programs, interest rate cuts, and asset purchases. The alphabet soup of recent Federal Reserve programs is too long to comprehensively analyze in this letter (ESF, PMCCF, SMCCF, TALF, MMLF, VRDNS, and CPFF).

The Federal Reserve’s loans to repo markets have the goal of maintaining the federal funds rate within the target range. Repo markets can be thought of as a global marketplace for short-term liquidity and operate in a manner similar to pawn shops. Borrowers offer up collateral which is typically highly liquid and safe securities such as treasury bills. The less safe or liquid the collateral, the greater the percentage difference between an asset’s market value and the amount that can be used as collateral, known as a “haircut”.

The Fed has also eased the terms of their currency swap lines to foreign central banks. The swap lines that the Federal Reserve has are with 5 central banks; the Bank of Canada, European Central Bank, Bank of England, Bank of Japan and Swiss National Bank. However, there are many other central banks that will need to provide dollar liquidity to their financial sector due to the slowdown in international commerce. The traditional way of this occurring is by the central banks liquidating their reserve of US treasuries on the open market in order to collect dollars for domestic use. However, this may send the prices of the treasuries down and their yields up, the precise thing that the Federal Reserve is attempting to avoid. In order to prevent this, the Federal Reserve has created yet another program, the Foreign and International Monetary Authorities repurchase agreement facility (FIMA Repo Facility) which provides lending liquidity to an international repo market of treasuries. By doing this, the foreign central banks that are not part of these swap line relationships with the Federal Reserve can borrow dollars for their domestic markets without needing to dispose of their treasuries.

At over $2 trillion of various loans and grants, the CARES Act coronavirus relief program passed by Congress is the largest stimulus rescue package in history. This will blunt much of the impact of the Covid-19 crisis and will have downstream effects on consumer behavior that are difficult to predict. I encourage any US investors affected by the crisis who are self-employed or are business owners to look into the programs offered by this Act, especially the EIDL and PPP loans, to see what aid they may qualify for.

All of this stimulus and monetary intervention will have long-term effects on the value of the dollar. M2 money supply increased 8.6% just in Q1 2020 compared to 0.7% in Q1 20193. In normal circumstances, inflation is created from the interaction between aggregate supply and aggregate demand, but lockdowns mess with both sides of the equation. The significant risk of deflation due to the rapid decrease of economic activity this quarter was the motivation for expanding dollar liquidity. When this crisis passes, economic activity and aggregate demand will return, and the increased M2 money supply may lead to accelerated dollar inflation down in the future. Individual investors and institutions should be cognizant of how inflation will affect their ability to meet their spending requirements. Further, companies with pricing power will be better equipped to pass on these inflation increases to their customers.

Our Strategy Going Forward

The most important thing in evaluating businesses for investment today is the impact of the virus and the government response on their business model going forward. We face a similar situation to past financial crises in that historical financial statements and analyst consensus estimates both have reduced utility in evaluating the future prospects of equities.

We will need to rely on logic and qualitative evaluation of businesses to predict which companies are likely to be more impacted by the rapidly shifting situation. All of our portfolio companies in our portfolio and the vast majority of those not in our portfolio have decreased in price since the beginning of the year. When every stock has a rapid and symmetrical decrease in price, it does not offer much in the way of opportunities to trade around positions to reallocate to bargains. However, some companies deserve price decreases more than others as their fundamental value has been impaired to a greater degree by the crisis. We will trade around our positions as some of them recover in price back towards their fundamental value and others remain at depressed valuations.
The panic and selloff in equity markets may be a great positive for long-term equity investors like us. Low stock prices are a positive, because several of our holding companies are buying back their shares at cheaper prices. We receive dividends from several of our companies which we will now be able to reinvest at higher rates of return. For investors in the accumulation phase of their financial life, they will now be able to invest their new capital at these same higher rates of return. We plan to take full advantage of this opportunity.

It is my hope that researchers can develop a vaccine and effective therapies for critical cases as quickly as possible. Every day this epidemic continues results in more death and suffering.
Please do not hesitate to contact me with any questions.

Best regards,

Andrew Oskoui, CFA

Portfolio Manager

The post Blue Tower Asset Management 1Q20 Commentary: The paradox of value investing appeared first on ValueWalk.

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The Coming Of The Police State In America

The Coming Of The Police State In America

Authored by Jeffrey Tucker via The Epoch Times,

The National Guard and the State Police are now…

Published

6 hours ago

on

March 9, 2024

By

The Coming Of The Police State In America

Authored by Jeffrey Tucker via The Epoch Times,

The National Guard and the State Police are now patrolling the New York City subway system in an attempt to do something about the explosion of crime. As part of this, there are bag checks and new surveillance of all passengers. No legislation, no debate, just an edict from the mayor.

Many citizens who rely on this system for transportation might welcome this. It’s a city of strict gun control, and no one knows for sure if they have the right to defend themselves. Merchants have been harassed and even arrested for trying to stop looting and pillaging in their own shops.

The message has been sent: Only the police can do this job. Whether they do it or not is another matter.

Things on the subway system have gotten crazy. If you know it well, you can manage to travel safely, but visitors to the city who take the wrong train at the wrong time are taking grave risks.

In actual fact, it’s guaranteed that this will only end in confiscating knives and other things that people carry in order to protect themselves while leaving the actual criminals even more free to prey on citizens.

The law-abiding will suffer and the criminals will grow more numerous. It will not end well.

When you step back from the details, what we have is the dawning of a genuine police state in the United States. It only starts in New York City. Where is the Guard going to be deployed next? Anywhere is possible.

If the crime is bad enough, citizens will welcome it. It must have been this way in most times and places that when the police state arrives, the people cheer.

We will all have our own stories of how this came to be. Some might begin with the passage of the Patriot Act and the establishment of the Department of Homeland Security in 2001. Some will focus on gun control and the taking away of citizens’ rights to defend themselves.

My own version of events is closer in time. It began four years ago this month with lockdowns. That’s what shattered the capacity of civil society to function in the United States. Everything that has happened since follows like one domino tumbling after another.

It goes like this:

1) lockdown,

2) loss of moral compass and spreading of loneliness and nihilism,

3) rioting resulting from citizen frustration, 4) police absent because of ideological hectoring,

5) a rise in uncontrolled immigration/refugees,

6) an epidemic of ill health from substance abuse and otherwise,

7) businesses flee the city

8) cities fall into decay, and that results in

9) more surveillance and police state.

The 10th stage is the sacking of liberty and civilization itself.

It doesn’t fall out this way at every point in history, but this seems like a solid outline of what happened in this case. Four years is a very short period of time to see all of this unfold. But it is a fact that New York City was more-or-less civilized only four years ago. No one could have predicted that it would come to this so quickly.

But once the lockdowns happened, all bets were off. Here we had a policy that most directly trampled on all freedoms that we had taken for granted. Schools, businesses, and churches were slammed shut, with various levels of enforcement. The entire workforce was divided between essential and nonessential, and there was widespread confusion about who precisely was in charge of designating and enforcing this.

It felt like martial law at the time, as if all normal civilian law had been displaced by something else. That something had to do with public health, but there was clearly more going on, because suddenly our social media posts were censored and we were being asked to do things that made no sense, such as mask up for a virus that evaded mask protection and walk in only one direction in grocery aisles.

Vast amounts of the white-collar workforce stayed home—and their kids, too—until it became too much to bear. The city became a ghost town. Most U.S. cities were the same.

As the months of disaster rolled on, the captives were let out of their houses for the summer in order to protest racism but no other reason. As a way of excusing this, the same public health authorities said that racism was a virus as bad as COVID-19, so therefore it was permitted.

The protests had turned to riots in many cities, and the police were being defunded and discouraged to do anything about the problem. Citizens watched in horror as downtowns burned and drug-crazed freaks took over whole sections of cities. It was like every standard of decency had been zapped out of an entire swath of the population.

Meanwhile, large checks were arriving in people’s bank accounts, defying every normal economic expectation. How could people not be working and get their bank accounts more flush with cash than ever? There was a new law that didn’t even require that people pay rent. How weird was that? Even student loans didn’t need to be paid.

By the fall, recess from lockdown was over and everyone was told to go home again. But this time they had a job to do: They were supposed to vote. Not at the polling places, because going there would only spread germs, or so the media said. When the voting results finally came in, it was the absentee ballots that swung the election in favor of the opposition party that actually wanted more lockdowns and eventually pushed vaccine mandates on the whole population.

The new party in control took note of the large population movements out of cities and states that they controlled. This would have a large effect on voting patterns in the future. But they had a plan. They would open the borders to millions of people in the guise of caring for refugees. These new warm bodies would become voters in time and certainly count on the census when it came time to reapportion political power.

Meanwhile, the native population had begun to swim in ill health from substance abuse, widespread depression, and demoralization, plus vaccine injury. This increased dependency on the very institutions that had caused the problem in the first place: the medical/scientific establishment.

The rise of crime drove the small businesses out of the city. They had barely survived the lockdowns, but they certainly could not survive the crime epidemic. This undermined the tax base of the city and allowed the criminals to take further control.

The same cities became sanctuaries for the waves of migrants sacking the country, and partisan mayors actually used tax dollars to house these invaders in high-end hotels in the name of having compassion for the stranger. Citizens were pushed out to make way for rampaging migrant hordes, as incredible as this seems.

But with that, of course, crime rose ever further, inciting citizen anger and providing a pretext to bring in the police state in the form of the National Guard, now tasked with cracking down on crime in the transportation system.

What’s the next step? It’s probably already here: mass surveillance and censorship, plus ever-expanding police power. This will be accompanied by further population movements, as those with the means to do so flee the city and even the country and leave it for everyone else to suffer.

As I tell the story, all of this seems inevitable. It is not. It could have been stopped at any point. A wise and prudent political leadership could have admitted the error from the beginning and called on the country to rediscover freedom, decency, and the difference between right and wrong. But ego and pride stopped that from happening, and we are left with the consequences.

The government grows ever bigger and civil society ever less capable of managing itself in large urban centers. Disaster is unfolding in real time, mitigated only by a rising stock market and a financial system that has yet to fall apart completely.

Are we at the middle stages of total collapse, or at the point where the population and people in leadership positions wise up and decide to put an end to the downward slide? It’s hard to know. But this much we do know: There is a growing pocket of resistance out there that is fed up and refuses to sit by and watch this great country be sacked and taken over by everything it was set up to prevent.

Tyler Durden Sat, 03/09/2024 - 16:20

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Low Iron Levels In Blood Could Trigger Long COVID: Study

Low Iron Levels In Blood Could Trigger Long COVID: Study

Authored by Amie Dahnke via The Epoch Times (emphasis ours),

People with inadequate…

Published

10 hours ago

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March 9, 2024

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Low Iron Levels In Blood Could Trigger Long COVID: Study

Authored by Amie Dahnke via The Epoch Times (emphasis ours),

People with inadequate iron levels in their blood due to a COVID-19 infection could be at greater risk of long COVID.

(Shutterstock)

A new study indicates that problems with iron levels in the bloodstream likely trigger chronic inflammation and other conditions associated with the post-COVID phenomenon. The findings, published on March 1 in Nature Immunology, could offer new ways to treat or prevent the condition.

Long COVID Patients Have Low Iron Levels

Researchers at the University of Cambridge pinpointed low iron as a potential link to long-COVID symptoms thanks to a study they initiated shortly after the start of the pandemic. They recruited people who tested positive for the virus to provide blood samples for analysis over a year, which allowed the researchers to look for post-infection changes in the blood. The researchers looked at 214 samples and found that 45 percent of patients reported symptoms of long COVID that lasted between three and 10 months.

In analyzing the blood samples, the research team noticed that people experiencing long COVID had low iron levels, contributing to anemia and low red blood cell production, just two weeks after they were diagnosed with COVID-19. This was true for patients regardless of age, sex, or the initial severity of their infection.

According to one of the study co-authors, the removal of iron from the bloodstream is a natural process and defense mechanism of the body.

But it can jeopardize a person’s recovery.

“When the body has an infection, it responds by removing iron from the bloodstream. This protects us from potentially lethal bacteria that capture the iron in the bloodstream and grow rapidly. It’s an evolutionary response that redistributes iron in the body, and the blood plasma becomes an iron desert,” University of Oxford professor Hal Drakesmith said in a press release. “However, if this goes on for a long time, there is less iron for red blood cells, so oxygen is transported less efficiently affecting metabolism and energy production, and for white blood cells, which need iron to work properly. The protective mechanism ends up becoming a problem.”

The research team believes that consistently low iron levels could explain why individuals with long COVID continue to experience fatigue and difficulty exercising. As such, the researchers suggested iron supplementation to help regulate and prevent the often debilitating symptoms associated with long COVID.

“It isn’t necessarily the case that individuals don’t have enough iron in their body, it’s just that it’s trapped in the wrong place,” Aimee Hanson, a postdoctoral researcher at the University of Cambridge who worked on the study, said in the press release. “What we need is a way to remobilize the iron and pull it back into the bloodstream, where it becomes more useful to the red blood cells.”

The research team pointed out that iron supplementation isn’t always straightforward. Achieving the right level of iron varies from person to person. Too much iron can cause stomach issues, ranging from constipation, nausea, and abdominal pain to gastritis and gastric lesions.

1 in 5 Still Affected by Long COVID

COVID-19 has affected nearly 40 percent of Americans, with one in five of those still suffering from symptoms of long COVID, according to the U.S. Centers for Disease Control and Prevention (CDC). Long COVID is marked by health issues that continue at least four weeks after an individual was initially diagnosed with COVID-19. Symptoms can last for days, weeks, months, or years and may include fatigue, cough or chest pain, headache, brain fog, depression or anxiety, digestive issues, and joint or muscle pain.

Tyler Durden Sat, 03/09/2024 - 12:50

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February Employment Situation

By Paul Gomme and Peter Rupert The establishment data from the BLS showed a 275,000 increase in payroll employment for February, outpacing the 230,000…

Published

11 hours ago

on

March 9, 2024

By

By Paul Gomme and Peter Rupert

The establishment data from the BLS showed a 275,000 increase in payroll employment for February, outpacing the 230,000 average over the previous 12 months. The payroll data for January and December were revised down by a total of 167,000. The private sector added 223,000 new jobs, the largest gain since May of last year.

Temporary help services employment continues a steep decline after a sharp post-pandemic rise.

Average hours of work increased from 34.2 to 34.3. The increase, along with the 223,000 private employment increase led to a hefty increase in total hours of 5.6% at an annualized rate, also the largest increase since May of last year.

The establishment report, once again, beat “expectations;” the WSJ survey of economists was 198,000. Other than the downward revisions, mentioned above, another bit of negative news was a smallish increase in wage growth, from $34.52 to $34.57.

The household survey shows that the labor force increased 150,000, a drop in employment of 184,000 and an increase in the number of unemployed persons of 334,000. The labor force participation rate held steady at 62.5, the employment to population ratio decreased from 60.2 to 60.1 and the unemployment rate increased from 3.66 to 3.86. Remember that the unemployment rate is the number of unemployed relative to the labor force (the number employed plus the number unemployed). Consequently, the unemployment rate can go up if the number of unemployed rises holding fixed the labor force, or if the labor force shrinks holding the number unemployed unchanged. An increase in the unemployment rate is not necessarily a bad thing: it may reflect a strong labor market drawing “marginally attached” individuals from outside the labor force. Indeed, there was a 96,000 decline in those workers.

Earlier in the week, the BLS announced JOLTS (Job Openings and Labor Turnover Survey) data for January. There isn’t much to report here as the job openings changed little at 8.9 million, the number of hires and total separations were little changed at 5.7 million and 5.3 million, respectively.

As has been the case for the last couple of years, the number of job openings remains higher than the number of unemployed persons.

Also earlier in the week the BLS announced that productivity increased 3.2% in the 4th quarter with output rising 3.5% and hours of work rising 0.3%.

The bottom line is that the labor market continues its surprisingly (to some) strong performance, once again proving stronger than many had expected. This strength makes it difficult to justify any interest rate cuts soon, particularly given the recent inflation spike.

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