Metaphorical Creativity
By Julien B. Booth
November 10, 2015
We do our best to make our bi-monthly investment updates as engaging and pithy as possible. However, after 7+ years of obsessing about interest rates, I find myself metaphorically challenged. For the 5th time this year we are bumping against the upper range of the 10 year bond: 2.33%. The market, in its wisdom, is once again having another tantrum about interest rates; yet we started the year with 2.21% on the same bond. (note: prices and yields move inversely)
We are approximately 78 months into a recovery (avg. recovery about 50 months), corporate earnings are receding, commodity prices have collapsed (per strong US $), China (2nd largest economy) is rapidly slowing, and we are now, once again, obsessing about the Fed raising rates (which will merely further boost a strong US $). A strong US $ puts massive pressure on commodity-based economies and currencies (Middle East, Canada, Mexico, etc.) and allow us to import deflation. Additionally, the strong US $ will only hurt large US company earnings by pressuring their exports.
Wall Street exists (in most cases) for its own benefit, notwithstanding the altruistic and heartfelt commercials their marketing teams create. Net, net – they are publically traded companies with profit as the motive so selling is their job. Lest we forget their last round of malfeasance (2008-2009
meltdown). Hence, they like to keep an informational advantage over their “customers”.
To our chagrin, most investors are never educated on the capital structure of a company. The capital stack of any company (see diagram) is comprised of a host of securities that are senior obligations of a corporate entity. Our research company begins the analysis process by understanding the credit quality of a company before its stock merits for a simple reason: Equity is the remainder/residual value of company after structurally senior obligations are satisfied.
Wall Street and institutional investors (in their knowledge) often prefer to own the senior securities for themselves. Hence, Wall Street loves to SELL those securities where it is paid most handsomely (IPOs of stock). Remember the altruistic commercials. Beware the big banks/insurance cos. There is a substantial reason they abhor the FIDUCIARY role.
At the beginning of any new client conversation, we often step back from the “long term investor” conversation and say: “Where is VALUE today”? After all, our job (Forest Capital) is to generate return with moderate to low underlying risk, immediately, not always rationalizing things over the long-term. We will all be dead over the long-term. With starting (present) valuations back (after August -13% drawdown) at very high historical levels, and entering a potential interest rate tightening cycle, we find only modest value in stocks Today. See chart below.
We are finding value in closed end funds TODAY. The interest rate tantrums of the past year(s) always spook the poor souls that were SOLD closed end funds at IPO (NEVER BUY @ IPO, EVER). With discounts in excess of 15% to NAV and yields above 8% (taxable) and 5% (tax free) we believe the risk is fully priced. We are buyers at these levels.
Quick Primer: http://www.forestcapital.net/admin/photos/Wknd%20Notes%20%208_4_15%20Closed%20End%20Funds%20Primer(2).pdf
Finding value is a transitory concept and can change week to week. Our search for value is driven by the simple axiom that we buy the same assets for our clients as we would for ourselves. Eating our own cooking, if you will.
As usual, thank you for investing with Forest Capital! For additional information on portfolio positioning, please contact Forest Capital directly at jbooth@forestcapital.net.
