cyclical investments

Rule #2

© Can Stock Photo / ragsac

We often talk about our three fundamental principles of investing. Rule #2 is ‘Buy the best bargains.’ This is our intent, but we must act on what we know, which is incomplete. Our crystal ball does not actually work; we do not know the future. No guarantees.

The best bargain is likely to be unpopular – or else it might not be a bargain. We often buy into sectors that are down sharply from much higher levels, years before. The crowd is almost never rushing into shares that have declined 50 or 80% over a period of years.

This matches up nicely with our contrarian philosophy, doing our own thinking, going our own way. In fact, we believe that profit potential lives in the gap between the consensus expectation and the unfolding reality. We think there is an edge in finding a lonely, but correct, position.

There are different categories of bargains. The best bargain might be a cyclical investment at the low point in its cycle – homebuilders in recession, for example. Or a wonderful, durable blue chip company available at a temporarily low price because of some short-term issue. Or a deeply discounted bond in a stressed company that we figure is trading below liquidation value. No guarantees, as we said!

Our approach is not the only one. Some believe in buying only when an investment is already in a clear up-trend. Others want to own the things that are on the magazine covers, the ones everyone is talking about. For better or worse, we do our best to stick to our convictions. (And sometimes they are better, and sometimes they are worse.)

The value style, our philosophy, is right for us. Clients, if you would like to talk about this or anything else, please email us or call.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Bargain Hiding in Plain Sight

© Can Stock Photo / mrivserg

Imagine a product that has these uses1:
• Vital part of every home and building.
• Goes into every vehicle; hybrids and electrics use up to four times more.2
• Needed for manufacture, installation and use of solar panels and wind turbines.
• Key requirement in making batteries.

One might imagine that demand for this product will rise in coming years, as technology changes our power grid and transportation, and the world continues to modernize.

Now consider the supply side. It takes billions of dollars and four years or more to create a new production facility. The industry that produces it went through a depression as prices for the product got cut in half from 2011 to 20163. Revenues disappeared, losses mounted, spending got slashed. New projects were cancelled.

Rising demand, constricted supply: we know how this works. Prices will rise, revenues and earnings for producers will go up, stock prices may follow. No guarantees, of course, and the timing is always uncertain.

The product is COPPER. There is no replacement for it. The question we face as investors is, can we get involved on a favorable basis?

We know companies that produce a lot of copper, along with other resources. Their stocks are traded on the New York Stock Exchange. The valuation on their shares seems compelling. A dollar of profit in one trades for a third less than that of the average stock; the other one carries a two-thirds discount. One is trading at one-third of its all-time peak a few years back, the other is discounted even more.

Both stocks have been about twice as volatile as the average stock. (This is measured by a statistic called ‘beta.’) We don’t care. Downside volatility is wonderful if you are trying to buy bargains. But owners should be prepared for the roller-coaster.

Clients, we are telling you this story for a reason. When you hear that ‘the market is too high’ or things are at some unsustainable peak, remember that at 228 Main, we are pounding the table and jumping up and down about the bargains we are finding. If you would like to discuss this or anything else at greater length, please email us or call.

1The World Copper Factbook 2014, International Copper Study Group

2The Electric Vehicle Market and Copper Demand, International Copper Alliance

3Federal Reserve Bank of St. Louis

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

Investing involves risk, including possible loss of principal.

The fast price swings in commodities and currencies will result in significant volatility in an investor’s holdings.

The Rear View Mirror and the Windshield


Nobody we know would drive down the highway with eyes glued firmly to the rear-view mirror. The mirror tells us only where we’ve been. The windshield, on the other hand, gives us information about the road ahead.

Yet an investment method popular with many financial representatives and firms relies on a combination of rear view imagery and elaborate statistical calculations. Years of data about the behavior of different investment sectors is fed into a computer program, which spits out the optimal proportions for ownership of every sector. It is said to deliver hopes of the best returns for a given level of volatility.

We see three flaws with this method, called Modern Portfolio Theory or MPT.

The future will not be like the past. MPT is really just high definition, computer-assisted hindsight. It tells you what would have worked up to now, by looking only into the rear-view mirror. Many financial crises provoke a lot of disappointment in people with MPT portfolios.

Our behavior changes with our experiences, thereby changing the future. It was thought going into the 2007-2009 financial crisis that mortgages were safe investments because people always paid them first, even if they couldn’t pay other bills. In reality, auto loans outperformed while mortgages went unpaid. Consequently, the next crisis may well feature large losses in auto loans as too much capital has poured into this ‘safer’ category. MPT cannot see these kinds of dynamics.

People attribute more certainty to MPT computer output because it calculates portfolio holdings and potential variation in account value out to two decimal places. They forget that these are estimates. Adding detail to what is basically a guess does not make it more accurate.

Clients, you have heard us talk about our three principles over and over again. They help us assess the economic and investment landscape. They give us a way to think about how the future might unfold. Although we have no guarantees to offer, or even assurances that our methods are better, at least we are trying to look out the windshield—instead of focusing on the rear-view mirror!

We would rather figure out how to live with volatility and aim for higher returns instead of pretend that focusing on the rear-view mirror will save us grief in the future. If you would like to discuss your situation in more detail, please email us or call the shop.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Investing involves risk, including possible loss of principal.