JANUARY 2012
During January the Pegasus fund was up 0.5%. Given the squeeze on so many of our shorts and the, now traditional, January mean reversion we are comfortable, if not pleased, with that figure. The inter-stock correlation is still significant and it does make life difficult for the stock picker. To illustrate this the Zero Hedge blog pointed out that between 1990 and 2000 there were 29 days when 80% of the stocks in the S&P 500 moved in the same direction. Since July last year there have been 35. We aren’t complaining, the market is tricky but the situation will not last forever, correlations break down and we will be well positioned to capitalise when they do.
This monthly attribution piece is going out separately to an in depth piece we have done on David’s findings following his visit to the Bakken shale oil formation in North Dakota.
The tone of this attribution piece reads remarkably similar to that of January’s 2011. Last year we wrote "only 3 out of 19 sectors didn’t reverse the direction of the previous year during the month". So doing the calculation again for this year we find that 6 out of 19 sectors didn’t reverse 2011’s direction. This is very normal in January, it is mainly market psychology that drives this and it tends to unravel again in the following months.
It is perfectly reasonable to ask why, as we know this is likely to occur, we don’t just reverse all our trades in January? Whilst awareness of the pattern is reflected in the timing of trades and around the margins of the portfolio, wholesale structural changes would be cavalier as it would, by definition, involve shorting stocks you like and buying those you think are flawed. Absorbing the short term volatility in the portfolio is something we are disciplined and experienced enough to do.
Having said that we certainly did not expect the bank stocks to bounce as much as they did. In a climate of hate that saw Stephen Hester being hounded into foregoing a contractually agreed bonus and Fred Goodwin being deknighted, it is strange that both Royal Bank (up 42%) and Lloyds (up 18%) led the charge. We are short Lloyds and still see significant problems ahead, problems which are not reflected in the valuation. The market capitalisation of Lloyds is still the same (give or take) as it was in October 2005. Admittedly it now owns HBOS, which it didn’t then, but it would take a more sanguine analyst than us to consider that a good thing. The sector that leads you into trouble does not lead you out. It will be no different this time.
The strange nature of January was also reflected in the movement in the retailers. Tesco’s warning is a very significant event for the UK. We would be very surprised if many investors would have predicted Marks to be up 5% during a month where the biggest retailer in the UK brings analyst forecasts down by 20%. We were not short Tesco at the time of the warning; however we are materially short of the sector and are comfortable with the position. By way of corroboration of our stance, Supergroup was one of our biggest losers in January, the shares rising almost 30%. Since the month end they have been forced to warn again and the shares are pretty much back to the level they started the year at. We think they will fall further.
Continuing on the retailers, a stock we covered in the January newsletter last year, and another which exhibited a big mean reversionary move during the month this year is Home Retail Group. Coincidently Home retail group bounced sharply in January last year as well. Prompting us to write at the time "Despite the squeeze in Home Retail Group on the back of an in line trading statement we have maintained the short. The group is facing considerable structural challenges at a time when their customer base is having a pretty tough time". When we wrote that the shares had bounced from 188p to 212p. So as I write now the shares bounced a similar percentage in January 2012 but the price went from 90p to 106p. We are running the short and we can see the shares doing as badly, if not worse than they did in 2011. Structural change in your marketplace is largely irresistible, just ask HMV, Game group or even Kodak.
We avoided the mining sector for almost all of 2012. We didn’t feel we could add much value by holding macro dominated stocks in a macro dominated market. We have now established a holding in Glencore. Whilst it was an unremarkable contributor in January it is worth mentioning as it is a change in stance for us. Of all the mining companies Glencore is less of a call on the direction of commodity prices. The attraction to us is of holding a company which has demonstrated a tremendous ability to make outstanding trading returns across market conditions. The entry point was extremely important to us and, having avoided the IPO at 530p, we started buying the stock at the 370p level, not that we are blowing our own trumpet here as we were not astute enough to short them. We are heartened by their move to buy in Xstrata. To put it succinctly, Glencore know far more about the mining cycle than we do. They could have bought in the rest of Xstrata at any time. That they are choosing to do so now it gives us confidence at the opportunities they see.
AD