A Bit of Tactical Trimming

The new year finds us as bullish as ever about the Market’s longer term prospects, but on balance, a seller of stocks. With the Market having over the past four months put up what could be deemed a healthy two years worth of appreciation (i.e., RUT +37%) it is clearly in need of some kind of breather. It is safe to say that in the months ahead we will see a correction of at least 6%. For all we know, it has already started. We don't want to repeat last April's experience of being too greedy when the Market was similarly bubbling up. I endured last summer's -17% correction with very limited flexibility to take advantage of all that distressed priced merchandise that developed along the way. This time, I am taking “salami slice” profits on a number of holdings that have made “gone ballistic” moves, and (finally) pulling the trigger on some holdings that could be considered “reasonably priced legacies of my prior situation”. This should insure not only that I have firepower when the inevitable correction develops but also another year of living (by my rather frugal standards) large (i.e., remodeling this wreck of a homestead, numerous fishing trips, non-rotgut libations).

Before elaborating on what drives this tactical departure from what at times might seem perma-bull exuberance, a bit of an aside is in order to account for the time passed since the last Musings. Taking advantage of that plunge in air fares that occurs on about January 5, we visited that corner of the country that, have prospered as it has since we moved away 25 years ago might be called Pugetopolis. We had a very good time, but Seattle is a dreary place this time of year. In the ten days we were there, I think I saw the sun shining for not quite one hour. Having grown up there, I knew its winters were dark, damp and, for some, depressing, but having been gone for so long, I was struck by the way that it feels like it’s about a half hour before sundown pretty much all day. It is a metropolis still struggling to shake off a bust in a real estate market that for at least two decades seemed as if it could only go up. One bright moment for me was during a Sunday brunch, in a kitchen with a great view of bunch of houses, some of which I am sure have a great view of Puget Sound, and seeing the 787 fly by for the first time. Not only is it a beautiful aircraft, but I think I saw what should be an investor’s “gift that keeps on giving” that should last for at least the rest of my mortal life.

Based on an assiduous study of the micro-brewing industry of greater Ballard, I was able to determine that discretionary consumer spending in that hard hit city is no longer dormant, though it is possible that living in Seattle during winter months has rendered beer drinking a non-discretionary form of consumer spending. I was ready to return to Texas, though the weather upon our arrival was such that it was not clear we had left Seattle, but that, in true Texas fashion, changed quickly (and continues to do so). I look forward to visiting Seattle again, but I have to say that it seems more and more like a different country. Perhaps the adversity of the era will dial this down, but it seems to me that one of the biggest things that make places like it different than here in the heartland is a relative dearth of “grown-ups” in the electorate. You know, the kind of folks who are willing to dig in their heels and say no to the do-gooders and various other perpetrators of harebrained schemes looking to tickle their own self-worth with Other People’s Money. Like so many other, typically coastal, places where this has been the case, this part of the country has a tough fiscal road ahead of it trying to pay for or derail a plethora of accumulated boondoggles.. Principled opposition to whole classes of people living large on the State’s power to be “compassionate” on someone else’s dime is much more evident in Texas, which is is one more reason that places like Texas continue to prosper.

Travel means lots of reading, and Christmas brought a bunch of books that had been “suggested” (Amazon makes it so easy!). Tempting as it might be to use Musings to hold forth on so much of what I read, I will limit myself to one, singularly ironic observation. Paul Johnson’s Churchill (Penguin, 2010) provides an overview of a great man’s life that is a once rapidly paced and laden with anecdotes. The irony that struck me as I absorbed this story revolves around a bit of reportage circulating about the upcoming royal wedding in the U.K. Perhaps it is mere gossip, but it has been stated that the President of the U.S. will not be invited. (Did the iPod loaded with speeches not go over so well?) This reminded me that one of the first things the new Administration did was remove a bust of Mr. Churchill from the White House and return it to the British Embassy. The heedlessness of this act becomes even more clear when one compares these two men. Churchill was profoundly prepared to lead his country through “its darkest hour”: a long life of ministerial service, participation in at least ten military campaigns, numerous failures that forged his character and a prolific (estimated at up to 10MM words) literary career. He was not the drunken lay-about that his detractors would have us believe (though he did, at age 72, tell a sixteen year old Johnson, who had asked him the secret of his success, that it was “conservation of energy. Never stand when you can sit, or sit when you can lay down.” And then he got into his limo and rode away.) Contrast this with what all but the most rabid of his defenders would acknowledge as our President’s the utter lack of preparation for the task that has been his to undertake. Whatever the basis of the animus that banished that statue might be, he would do well to look at Churchill’s life and learn what the stuff of leadership is really all about.

So the midwinter break is over, and here we are in what I see as still early-to-mid innings of a Bull Market, but raising some cash. What gives? Part of it has already been alluded to. The Market has come a long ways in a hurry. The relatively meager 23%+ rise in DJIA off its July 1 bottom is not exactly a barnburner, though with dividends this, too, could be considered a not bad two or even three year total return. But the real action has been in the aforementioned Russell 2000, or the NASDAQ’s 27.7% rise. These indices better reflect the way Musing’s has thus far invested. Based on the data, other than the initial decompression following a 1933, 1974, 2009 moment, it is highly unusual for the Market to advance much more than about 20% without sustaining some kind of pullback. We are there. Animal spirits could carry it somewhat higher in the weeks ahead, but maybe not. A correction will occur, and we want to be out of stocks we are most ambivalent about and sitting with at least some of that dead but eventually deadly asset that goes by the name of Cash. For me, holding more than 10% in cash has always been something of a statement. That is about where I am right now, and it will go another 5+% higher when I get the cash portion that will come from the buy-out of LDSH (am definitely hanging on to the ATI stock portion). This is not a call to start hedging or shorting. Money will likely be made on the short side at some point during 2011, but at least as much will be lost by smart guys who remind me of myself about fifteen years ago, who have yet to accrue those scars one gets being (ultimately) right but early betting against “overvalued” stocks. I have no idea exactly when it will start or how much it will correct. Rest assured, though, that something as arcane as a shortage of goat feed in Macedonia will trigger a sell-off, and the hedge funds, prop desks and all their friends will see to it that the reflexivity described in The Alchemy of Finance gives us at least a season of fear-based pricing. Now is the time to insure that one has the fiscal and emotional flexibility to start buying when fear leaks back into the atmosphere.

This tactical advice in no way diminishes my sense that barring something out the proverbial left field, this is still a young (but perhaps winded) Bull. We are less than two years removed from what was probably a once in a generation blow-out. We have already had a very healthy correction that ran from April 26 to September 1. And what are the alternatives? Certainly not bonds! Commodities might keep going, but when do you sell them? The only asset class besides equities that might possibly be mispriced in the good sort of way is Real Estate, but certainly not in every market, and only if one is knowledgeable about a particular market. Investors will fuel this Bull Market higher in 2011 and beyond because they have so few credible alternatives to put their money to work (a stark imperative in a defined-contribution-retirement-plan world). And finally, it has been a very long time since we have seen a silly season in Tech, and that seems to be getting underway. It might not get like 1999, but it already seems a lot like 1996, at least around those companies that are “going to change everything” and, oh, by the way, will be looking to go public and/or liquify their principal owners. I intend to be along for the ride, but by resisting the greedy urge to make as much as possible (i.e., raising cash), will be taking advantage of the inevitable bumps in the road to Digital Nirvana.

PS: The one stock I have bought in recent weeks: INTC. Such a strong company, with miles to go in leveraging its advantages. The bull case so timidly rendered, the bear case so flagrantly overwrought. And so cheap! The fever will break, and the multi-year, double digit total return will follow.