more on reversion to the mean

Happy Halloween!!!  

Trick or Treating for all!!!

This is a continuation of my post from yesterday.

why value works less well today

I’m a growth investor by temperament.  But I’ve spent more than half of my working career as an analyst and portfolio manager in value shops.  My basic contention is that traditional value investing works much less well in a globalized and post-Internet world than it did previously.

Why do I think this?

One of the two basic premises of value investing is that a firm’s investment in plant, equipment, distribution networks and brand name have a value that is substantial and that endures despite current mismanagement or battering by the business cycle.  The Internet has upended a lot of this, and the ability to move production to the emerging world has done more.

(The second premise is that change of control–either though action by the board of directors or by outside influences–is possible.  True in the US, but very often not elsewhere.  Twenty five years of activist investor failure in Japan is the most notable example.  But continental Europe is just the same.)

flavors of value

I’ve written about this before.  Basically, some value investors buy stocks simply because they’re very cheap, period.  Others wait to identify a catalyst for change before they jump in.

Personally, I believe that in today’s world the latter is the far safer course.  Yes, you may miss the absolute bottom.  But you also have greater assurance that you’re not booking passage on a latter-day Flying Dutchman that is doomed to never go up.

growth and value cycles

Through most of my thirty years in the investment business, periods of value outperformance and growth supremacy were each relatively short and both contained within a four-year business cycle.  For the past fifteen years or so, the periods of one style or the other being in vogue have been much longer.  I don’t know why.  But this phenomenon may make slavish devotion to one style or the other riskier than it has been in the past.

Consumer Discretionary vs. Staples

Back to the uninformative Bloomberg discussion of Consumer Discretionary vs. Staples.  Is there anything to the idea that Staples may make a recovery vs. Consumer Discretionary?

Yes and no.

yes

I think conditions are beginning to come into place for Staples stocks in the US to begin to do well again.  Many Staples stocks have large international exposure, much of that in the EU.  Europe appears to finally have moved past the bottom of its Great Recession and to be beginning to recover.  So revenues for Staples companies there should begin to perk up.  More important, the euro has moved up by about 7% against the dollar since July.  So the dollar value of those recovering sales to a US firm with EU exposure will, I think, be surprisingly high.

It’s possible that a continuation of economy-damaging politics as usual in Washington will make even slow growth in the EU look relatively attractive.  A renewed global investor interest in Europe may well cause its currency to remain firm.

On the other hand, Consumer Discretionary has less foreign exposure and a greater tilt toward the Pacific.  China’s recent economic reacceleration is therefore a plus.  But there’s less chance of currency gain.

no?

If portfolio managers begin to reallocate money to Staples, where will the funds come from?  It’s not clear to me that it will come from Consumer Discretionary.  It might well come from Energy, Materials, Technology or Industrials–all more cyclical industries than Consumer Discretionary.  If so, both Discretionary and Staples might do well.  In fact, although I haven’t thought this through enough, my hunch is that this is what will happen.

To me, the relevant points are that Staples are statistically cheap and that there’s a reason to think better times are in store, at least for US-based firms.  Whether this potential outperformance comes at the expense of Discretionary is much less important.

 

reversion to the mean

Mean version has two senses:

1.  The first is important for traders, less so for investors.  It’s that if we construct a trend line or moving average for a stock from past prices, the stock will tend to trade in a reasonably well-defined band or channel around the trend.  In theory at least, one can make money by buying when the stock is at the lower edge of the band and selling when it’s at the higher edge.

2.  The second is a cardinal tenet for value investors.  It’s that over long periods of time stocks in general tend to rise and fall in line with overall earnings performance, which is, in turn, a function of the ebb and flow of nominal GDP.  Some stocks may have episodes where they perform far better than that.  Others may have extended periods when they fall far short of this mark, which in the US probably averages around +8% per year.  The value investor’s argument is that both classes, serial outperformers and serial underperformers alike, will inevitably see their fortunes reverse and their stocks revert to the long-term mean performance.

For high-fliers, this means they’ll, sooner or later, crash and burn.  For the stock market’s junk pile, on the other hand, its denizens will have periods when they’ll rise like the phoenix.  The latter are what value investors look for.

old school value investing

For some value investors, this is it.  This is all they do.  They run screens that find the cheapest stocks based on price/cash flow, price/earnings or price/assets–or some combination of the three.  And then they buy them.

I knew one who systematically went through books of charts looking for stocks that had experienced catastrophic drops (not a good strategy–once they figured out what he was doing, brokers began to send this guy charts with the price axis stretched out and the time axis compressed, so that every stock they touted looked like a train wreck.  Last I heard–I was hired to clean up the unholy mess he created–he was selling real estate in the Philippines).

Every investor is in some sense a contrarian.  At the very least, we all believe that the stock we are buying has more up left in it than the seller does, and the stock we are selling has less.  We also know the cardinal rule is to “buy low and sell high.”  Nevertheless, I think the simple strategy I just outlined, which is at the heart of the value investing practiced a generation ago, no longer works.

Why am I writing about this today?  

I was listening to Bloomberg radio in my car yesterday,when Dave Wilson repeated the observation of a market strategist that the divergence between the strong relative performance of the sector ETF for Consumer Discretionary and the weak outcome for Staples was as great as it was just before the Internet bubble popped in 2000.  What followed was a fierce reversion to the mean by both sectors.

The implication was that this factoid is significant.  As usual for Bloomberg, what or why was not forthcoming.

More tomorrow.

 

 

crowdsourcing IPOS are on the way

new SEC crowdsourcing rules…

Last year’s JOBS Act (Jumpstart Our Business Startups) made them possible.  To my mind, abuse of organizations like Kickstarter made them necessary.  But the prior Obama SEC chairman, Mary Shapiro–a really weird choice for a financial watchdog–declined to write rules enabling them (a previous head of the brokerage industry trade association, she also declined to prosecute anyone in the financial industry for causing the Great Recession).

Under the current chairman, Mary Jo White, the SEC is beginning to function again.  Last week, it completed a set of rules for public equity offerings through crowdsourcing rather than conventional  high-fee broker-led IPOs.

Generally speaking, the rules require online availability of offering documents that potential investors can peruse and set limits on the amount an individual can invest, based on his assets.

…solve some problems…

For one thing, the JOBS Act requires the SEC to write rules for crowdsourced IPOs.

For another, crowdsourcing has become a big business.  But up until now, there has been no way for a crowdfunder to offer–or contributors to demand–an equity interest in his project.

For example, according to Varietyfilmmakers have already raised almost $120 million for movie projects through crowdsourcing.  What do contributors get in return?   …DVDs maybe, or thank-you notes, or autographs.  In other words, not much.  Arguably this is the way the film industry traditionally works, but still…

The recent case of Zach Braff of Scrubs fame has been particularly irksome to crowdfunders.  He appears to have pocketed $3 million+ in Kickstarter money raised for a small “independent” movie, and then turned around and sold his film idea to a studio anyway.  Ouch!

…and created others

There are the obvious issues of possible fraud and of the adequacy of disclosure.

In addition, like angel or venture capital investing,

–these will be long-term projects, so investors will have to be patient,

–the failure rate will probably be high

–crowdsourced stocks will presumably be highly illiquid.  A marketplace for trading them will probably eventually develop.  Let’s hope it will be better than the pink sheets.

on the other hand…

Had crowdsourcing been available, my guess is this is the route Google would have chosen to go public, rather than through a conventional IPO that mostly benefits Wall Street insiders.

The chances of a payoff, however small they may be, are certainly better than the odds on a lottery ticket.

And who knows?  …crowdsourcing may lead to an invigorated equity culture that appeals to Millennials.

 

last week’s jobs numbers

There were actually two sets of figures published by the Bureau of Labor Statistics.  The Employment Situation report, which is normally released on the first Friday of the month but which was delayed by the government shutdown, and the JOLTS (Job Openings and Labor Turnover Summary) report for August.

The Employment Situation. released on October 22nd, showed the job market as essentially unchanged in September from prior months.  The initial estimate for September was a gain of 148,000 jobs, a bit less than the consensus forecast of domestic economists.  But the survey is accurate only to +/- 100,000.  And my impression is that economists’ estimates are just stabs in the dark, centered around the trend of recent months’ results.  So unchanged is the best characterization, in my view.

Revisions were benign, as well.  July was revised down by 15,000 to +89,000 positions;  August was revised up by 24,000 to 193,000.  The net change, +9,000 jobs, is statistically insignificant.

The JOLTS report for August, published on the 24th, and which I pay somewhat less attention to, wasn’t earthshaking, either.  The economy had 3.9 million unfilled jobs at the end of that month.  That’s about 100,000 more than in July and about a quarter million more than in August 2012.  The fact that more employers are looking to hire–all in the private sector, not government–is a good thing.

There is some controversy surrounding the JOLTS figures, however.  Why is the unemployment rate so high, at 7.2% of the workforce, when there are almost four million unfilled jobs?

One camp thinks factors like mismatches between, say, the location of the jobs and that of the unemployed is a big reason, but that four million is an ok number in a healing economy.  The other, which includes me, thinks that the JOLTS figures are evidence that a good chunk of current unemployment is structural rather than cyclical–caused by a fundamental mismatch between worker skills and job requirements.  If so, the only way the JOLTS number will come down is through retraining programs and changes in education policy from Washington.  Fat chance of either happening.  But if camp #2 is right, current indifference by government risks creating a permanent underclass of chronically unemployed that will be a big long-term problem.

The bottom line:  neither report has major short-term Wall Street implications.

3Q13 earnings for Wynn Resorts (WYNN)

3Q13

After the close yesterday, WYNN reported its 3Q13 earnings results.  Revenue came in at $1.39 billion, up 7% year on year.  Macau was up by 9.6% and Las Vegas by 1.1%.  The company posted EPS of $1.84, much higher than the Wall Street consensus of $1.65, and considerably ahead of the $1.48 WYNN tallied in the comparable period of 2012.

details

In my view, the basic WYNN story remains unchanged for now:

–The company is capacity constrained in the booming Macau market and will remain so until its new casino in the Chinese SAR, the Wynn Palace, opens in early 2016.  In the meantime, it is refurbishing and fine-tuning its existing capacity to boost profits and maintain competitiveness with new casinos currently being opened in Macau.  But it probably won’t keep pace with overall growth in that market.

–Las Vegas is flattish, which is good performance in a city suffering from the combined effects of slow economic recovery in the US, massive overcapacity created at the market peak and the continuing expansion of regional casinos in hard-strapped states looking for new sources of revenue.

The current situation is probably best summarized by the stock’s market capitalization, almost 95% of which represents the value of WYNN’s Asian subsidiary, Wynn Macau.  Some anticipation of the Wynn Palace’s opening must already be included in the latter’s price, since Las Vegas still accounts for a quarter of WYNN’s total EBITDA.

Massachusetts

Perhaps the most interesting thing about the company’s earnings conference call was Steve Wynn’s apparent distress at the shabby way in which he feels his company is being treated by Massachusetts as it applies for a casino operating license there.  The bone of contention seems to be the state regulator’s suspicion of anyone doing business in Macau.

My quick reading of the situation suggests the vetting process is a little weird.  On the one hand, Massachusetts wants to outdo New Jersey as the strictest venue for casino operation in the US.  On the other, it is still considering MGM, which is barred from doing business in NJ.  And it seems to be intimating that applicants will get more favorable consideration if they give financial support to local tourist boards.   It will be interesting, though not crucial for WYNN, to see how the process turns out.  My sense is it will be a much bigger black eye for Mass than for WYNN if its application ends up being rejected.

my take

I’ve been holding both WYNN and HK: 1128 (Wynn Macau) for a long time.  I’ve recently sold my position in the latter, both on the idea that I can buy it back next year, when the new Palace is nearer to opening and because my overall casino holdings (I also own LVS and HK:0027 (Galaxy Entertainment)) had become too large).

WYNN and 1128 are the best casino operators in their markets, in my opinion.  Las Vegas may be boosted by a better climate for the convention/meeting business in Las Vegas next year.  But I don’t see market-beating earnings acceleration for 1128 for at least seven quarters.  Yes, the stock has been a blockbuster performer in Hong Kong recently, up by over a third during the past three months.  But that’s a short-term negative, in my opinion, not a positive.

recent currency movements

Big macroeconomic changes that affect the relative investment attractiveness of countries vs. one another can play themselves out in two ways:

–changes in the local currency value of the country’s investable assets, and/or

–changes in the value of the country’s currency.

The easiest way to see this is to look at Japan.  The election of Prime Minister Shinzo Abe and the enactment of wide-reaching policy changes he campaigned on have produced two major effects so far:

-a one-year gain of 60% in the yen value of the Japanese stock market and

–a 20% fall in the yen against the US$.

The net result for a ¥-oriented investor is a bonanza–and more joy than the Topix has seen since the 1980s.  For a $-oriented investor, however, it’s a 28% gain.  That’s not much better than the 22% advance in dollars the S&P 500 achieved over the same span.

Looking more closely into the Japanese stock market, weak-yen beneficiaries (exporters and import-competing firms) have been rocket ship rides; domestic-oriented firms, especially those that use dollar-priced raw materials, have languished.

But this is old news.  What’s happening today?

The big movements I see are in the euro and the US dollar.

Over the past three months, the EU currency is up by 4% against the dollar and by 2% against the yen.  The dollar, in contrast, is down against everything except the Canadian currency.  It’s off by 5% against sterling, 4% against the euro, -3.5% against the Australian dollar, -2% against the yen, and -1% against the renminbi.

I think currencies are reflecting two main things:

–primarily, the belief that the EU is finally past the worst economically and is beginning the slow road back to recovery.  Same thing for the UK, only more so.

–secondarily, loss of faith in the US because of worse than usual policy paralysis in Washington.

The big question for investors of all stripes is whether we are in early days of a trend reversal or whether what we’re seeing is just white noise, or random currency movements that may soon reverse themselves.   The answer has important implications for portfolio positioning.

I’m in the former camp.  This means that in Europe, like in Japan a year ago (but on a smaller scale), I should be shifting away from foreign currency earners and toward users of foreign currency-denominated inputs.  I should be doing the opposite in the US.  So far, I’m only changing my (relatively minor) holdings in European stocks.  But I’m worming up to do more.

the heavy half: internet gambling and Native American casinos

The article in the Wall Street Journal that I mentioned in yesterday’s post contains information about the business of an online gambling company in the EU and about a Native American casino in the northwest US.  It contains one piece of disturbing information.

The article leads with a “shocking” conclusion:  almost no one wins when they gamble.

…Duh!

Didn’t anyone look at a table of the odds on different casino games?  Everything favors the house. )The one exception is poker, where, ex the video game variety, the house merely collects a fee for organizing the game.)   To me, the more surprising information is that over 10% of gamblers–both online and in the Naive American casino–who wer net winners over an extended period of time.

The much more concerning statistic is that in the Native American casino, 2.8% of the patrons were big enough losers that they made up 50% of that casino’s profits.  The next 8% provided another 30% of the house take.

From a purely pragmatic p&l standpoint, this is a potentially dangerous concentration.  From a social/ethical point of view, my guess is that a good chunk of that 2.8% are problem gamblers who should be getting medical care and not be allowed to wager.

The pragmatist would begin to calculate how likely it is that legislative action would bar the casino doors to at least some of these golden-egg-laying geese.  The deeper question, however, is whether gambling is like cigarette smoking.  In the latter case, I think no self-respecting person can be a shareholder–and thereby lower the cost of capital of an ethically unsound business and share in the profits of promoting a fatal addiction.

I have several observations:

1.  Other than online poker, it;’s not clear that online gamblers and frequenters of physical casinos have anything in common.  It’s also not clear that although the games have the same names, that the odds for various online games are the same as those in physical casinos.

2.  A career of living and working with professional stock market gamblers makes me think that some people go to casinos expecting to lose and find that has a cathartic effect. (I’ve always felt casino gambling is too much like work to be fun.)

3.  I’m willing to think that the experience of the single Native American casino studied is similar to what happens in other local casinos around the US.  But I don’t think any of these has much in common with the resort casinos in Las Vegas–and certainly nothing to do with the US-run casinos in Macau or Singapore.

4.  The high roller  business (people who gamble $1 million+ in, say, a weekend casino jaunt) is very different from the low roller business examined in the WSJ article.  We have the clearest view of this in Macau, where companies disclose separately their profits from high rollers and from everyone else.  The everyone elses lose on average around 20¢ of every dollar they bet on baccarat.  High rollers lose 3¢–and have about half of that rebated back to they by the casinos as a condition of getting their patronage.

How is this possible?  High rollers know the rules, have lots of experience and want to win.  Low rollers don’t know the rules, like the atmosphere and want to be entertained.

5.  In the resort casino model practiced in Las Vegas and being implemented by WYNN and LVS in Macau, gambling produces half the firm’s profits.  Rooms, food, shopping and entertainment make up the rest.  So, in a purely pragmatic sense, even if all the large losers are  self-destructively in need of medical help and are barred from patronizing casinos, resort casinos would lose at most a quarter of their income.