Saturday, June 14, 2008 10 comments ++[ CLICK TO COMMENT ]++

Third Avenue 2nd Quarter 2008 Commentary by Martin Whitman

Martin Whitman's Third Avenue commentary for the 2nd quarter was just published and let me comment on this thoughts. I'll by quoting most of the letter but I urge anyone that is interested to read the full letter.

(source: Third Avenue Funds 2nd Quarter Shareholder Commentary, April 30, 2008. All quoted material is by Martin Whitman except as noted.)

Martin Whitman isn't shy about venturing into (what seems like) extremely risky stocks. Of course, he is extremely skilled at distress investing and views these investments as safe (whereas the market thinks they are risky).

Of interest to me is the fact that Martin Whitman significantly increased his stake in MBIA and Ambac. Based on his prior letter, I wasn't sure if he was committed to Ambac since he only took a small position. But now I am confident that he views Ambac as being similar to MBIA. It is also interesting to note that he took a position in GMAC unsecured bonds. The important thing in my eyes is that these are due in 2011. I would love to buy distressed bonds if their maturity is short but I don't think small investors have access to these.

Primer On Distress Investing Asset Types

Distress Investing, as far as Fund management is concerned, seems to encompass four different businesses:

1) Issues that are to remain performing loans; are to be reinstated in the event of Chapter 11 filings; or, are to become the equivalent of zero coupon bonds. These credit issues are deemed by TAVF management to have at least a 90% probability of never missing a contracted for payment for interest, principal or premium; or, if they are to miss payments, to become the equivalent of zero coupon bonds where the pay-off at maturity would equal the principal amount plus interest and interest on interest. Third Avenue holds a number of these issues, which were acquired at yields to maturity of between 14% and 20%. Such issues are CIT Senior Unsecureds, GMAC Senior Unsecureds, MBIA Insurance Corp. Surplus Notes, and Standard Pacific Senior Unsecureds.

I don't understand what he means when he says we may end up with something equivalent to a zero coupon bond (any readers have any thoughts?). Would that be similar to a trade claim that needs to be paid first? Anyway, I think this first asset type is almost always out of the reach of most small investors. These are generally credit instruments that not traded on an exchange and require big lum-sum investments (just like the general bond).

2) Small reorganization (or liquidation) cases. These are cases where the administrative expenses incurred in reorganizing (or liquidating) the company far exceed any cash savings for the company arising out of not making interest payments on unsecured debt and undersecured debt to the amount of undersecurity. In small cases, a reorganization (or liquidation) has to take place in a hurry if there are to be any values left for pre-petition unsecured creditors. Such cases with which the Fund has been involved in recent years include Home Products International and Haynes International.

Small investors probably have a shot at this. Without knowing much about these investments, and simply based on what Whitman is saying here, the problem I see is that if you are wrong with the timing, you can get screwed. I mean, if the re-org has to happen quickly for pre-petition unsecured creditors to realize any value, and if the process takes too long, the original investors may end up with nothing.

3) Large reorganization (or liquidation) cases. These are Chapter 11 cases where the cash savings from not paying interest and principal on unsecured debt and undersecured debt to the amount of undersecurity, exceeds the administrative expenses of reorganization (or liquidation). Here, unlike small cases, speed is not necessarily of the essence. The most important large case with which the Fund has been involved in recent years is Kmart.

This the type that most of us can get involved in. These things can take a long time to unfold, stories may be all over the media, and small investors may have a shot at acquiring some of the fulcrum securities that will have value post-bankruptcy or post-liquidation.

4) Making capital infusions directly into issuers to financially strengthen them or, put in other words, to make them feasible. This has become an important new business for Third Avenue. During calendar 2008, the Fund has made capital infusions into MBIA Insurance Corp. through purchasing Surplus Notes; and has also acquired the common stocks of MBIA (Parent), Ambac and St. Joe. Fund management is currently looking at one other possible common stock deal.

Small investors have a good chance to participate in these opportunities--especially if the capital infusion happens through a public means such as a stock exchange or a public offering of some sort. Martin Whitman clearly believes that the capital infusion into the monoline insurers and St. Joe, a land bank/real estate company, is to keep them viable and financially strengthen them. One of the big risks with the monoline insurers is that they are heavily regulated so if you inject capital into the insurance company, you may never get it back for a long time. Fortunately, my impression is that the insurance regulators aren't as prone to mismanaging resources as other government officials (government regulators in industries such as utilities seem to be far worse, with companies deploying billions to build power plants sometimes not really knowing what's in store for them).

A Comment About Japan

The Fund has now been invested in Toyota Industries for 11 years. During that period, the company has performed brilliantly, while the market performance of Toyota Industries Common has been at best, so-so. As a consequence, TAVF was able to acquire Toyota Industries common during the quarter at 3 under six times flow-through earnings. Flow-through earnings reflect Toyota Industries’ equity in the undistributed earnings of portfolio companies; Toyota Motor Common is the principal portfolio issue held by Toyota Industries.

I cherry-picked his comment about Toyota Industries to illustrate something that worries me about Japan in the grand scheme of things. Whitman says Toyota Industries has been performing exceptionally well on the business front but its stock price hasn't been doing well. This doesn't generally matter if you are a long-term investor. The market misprices assets for various reasons and if the business is doing well, then you can distribute the profits to the shareholders. However, Japanese firms are unique in that they are not shareholder-friendly. I don't know how well Toyota Industries treats its shareholders but most Japanese companies will not initiate tactics to improve shareholder returns. Many companies, even if their business is doing well, simply sit on large piles of cash--or even worse: waste it on some useless new venture.

Even if I find a good company in Japan, I often wonder if the market will reward the pick. Given that companies themselves don't do much to unlock shareholder value, you are relying almost solely on the market price.

One other risk with Japan is the risk of valuation compression. Japanese stock market was so wildly overvalued that valuations of exceptionally well-performing companies haven't gone anywhere (you are talking about world-leaders). I think the valuation problem is less of an issue these days, given that half the stocks on the TSE trade below book value. But nevertheless, it is possible that valuations can still compress further. On a P/E basis, valuations still look high (however I believe this is because earnings are depressed and many of the top Japanese companies are cyclical industrial companies).

Bear Raids

Martin Whitman has been quite outspoken about the prevalence of bear raids these days. I have no idea what is happening out there but my view is that bears improve market efficiency. The question is what happens when speculations lead to a collapse in the business. This is particularly problematic for Wall Street investment banks, who generally depend on reputation to retain customers, and have a highly-leveraged balance sheet. A run on the bank can bring down anyone on the Street. Even the vaunted Goldman Sachs can potentially collapse within a week. Whitman comments on the Bear Stearns collapse:

The analysis of Bear Stearns Common Stock is simple. Assuming that Bear Stearns was credit-worthy, Bear Stearns Common was worth well over $100 per share, even assuming that there had been a material amount of permanent impairments, e.g., the asset management business was a disaster area. However, assuming that Bear Stearns was not credit-worthy, Bear Stearns Common was valueless.

It turned out that Bear Stearns was not credit-worthy...

There probably were a number of financial reasons for the Bear Stearns collapse. However, it appears as if the most important reason, by far, was a concerted bear raid designed to persuade principal customers, i.e., counterparties and principal creditors, that Bear Stearns was no longer credit-worthy. Further, the bears argued, it was easy, and cost-free, to transfer accounts from Bear Stearns to Bear Stearns’ competitors. Why take credit risks with Bear Stearns? Thus, a run on the bank.

Whitman places the primary reason for the collapse of Bear Stearns due to a bear raid. No one will know what really caused the collapse of Bear Stearns. It collapsed due to liquidity problems within a week without any material change in the business environment. Early in the week that it collapsed, it had ample liquidity (SEC and FedRes checked their books) but it collapsed by Friday due to lack of liquidity (when customers pulled their business).

Lehman Brothers is facing a similar problem as Bear Stearns. Everything looks fine but if customers pull their business then the run-on-the-bank will collapse Lehman regardless of how much money it has. This is one reason that I don't buy the reasoning by some that Lehman Brothers can't collapse now that it has access to the Federal Reserve lending window. My layperson view is that money means nothing in these situations. If customers lose confidence, that's the end of you. Period. Dick Fuld has navigated Lehman through treacherous waters in the past (1998 crisis for example) and he really needs to earn his paycheck here.

The monoline bond insurers have been facing similar problems in the sense that customers, rating agencies, and regulators don't want to do business with them (or in the case of rating agencies, downgrade ratings without any qualitative reasoning.) Fortunately, though, the monolines can't face liquidity problems due to the way the insurance contracts are structured. Even the CDS-type insurance contracts that are signed are nothing like the CDS contracts signed by hedge funds, investment banks, pension funds, and others, who dabble in the CDS market.

It seems as if it is now easier, and more economical, to conduct bear raids than has ever been the case heretofore – even before 1929.
1) There is no longer an uptick rule. Prior to July 2007 and since the early 1930’s, a common stock listed on the New York Stock Exchange (as was Bear Stearns Common) could be shorted only at a price that was higher than the last price or change of price.
2) There are now well-developed options markets, where one can go short without incurring any material cash outlays – say, buy put options and offset the cost of
put options, by selling call options.
3) It is now feasible to sell short specific indices, e.g., the Markit ABX.HE, the indices that track prices of residential mortgages.
4) Perhaps most important, the means are more available, and more effective than they have ever been, to spread rumors through new communications devices – the Internet and business television stations.

I think Whitman is a bit harsh with the bears and I think the first two reasons are weak. My opinion is that the uptick rule probably didn't alter the playing field much. I also don't know if the options market really does anything.

The last two points are bang on. The Markit home equity index is the biggest joke out there. The problem isn't so much that you can short the index. Rather, the problem is that accountants and risk management outfits are using the index to project losses far into the future. The index is thinly traded (it isn't like a major stock index), does not represent the true nature of the housing market, and has too-low of a sample of constitutents.

As for the media, well, that is always manipulated by the bulls and the bears. Bulls always hype their stocks and I guess the bears are learning to play that game now too. When you have William Ackman saying that all the monolines are going to go bankrupt within the first three months of the year, it clearly has an impact on the clueless investors and, not to mention, regulators. Or when you have Jim Cramer screaming for nationalization of the monolines, well, it certainly doesn't help matters. Overall, I am in favour of free speech and I think the media is fine.

Net-net, the bear raids seem beneficial for the Fund. The raids are beneficial if all they do is depress the prices of common stocks by propagandizing faulty analysis, e.g., Ambac and MBIA. TAVF can acquire securities at true bargain prices. However, insofar as bear raiders can actually reduce corporate values, e.g., Bear Stearns, where important customers and creditor constituencies were convinced that Bear Stearns was not credit-worthy, bear raiders can be a real problem. Since TAVF is not going to become a bear raider, Fund management’s job is to avoid those situations where bear raiders actually harm companies;

Bears likely help contrarian investors because they force stock prices to overshoot on the downside. The problem is when they cause a collapse in the company.

If you are long the monolines, you need to keep the following playbook being used by the bears:

Bear raids will continue unabated unless those people leading shortselling forays can be shown some downside, whether economic, legal or
both. For example, there appears to be a four-pronged approach toward
trying to destabilize MBIA as a going concern.
First, there are efforts to strip the holding company of assets so that the holding company might become insolvent. Second, there is pressure brought on the ratings agencies to remove the AAA ratings from MBIA’s insurance subsidiaries. Third, there are pleas to regulators suggesting that they restrict the insurance subsidiaries’ ability to write policies. Finally, and as part of the other three, the bear raiders are trying to discourage clients from doing business with MBIA. None of these actions seem to have any merit at all. But from the bear raiders point of view, why not press these approaches? After all, there is no downside.

The 2nd event has already unfolded: MBIA has lost its AAA rating. The third bear tactic is the most dangerous to MBIA and Ambac right now. There is strong pressure on the regulators to do something--even though Ambac cannot be shown to be insolvent or has missed any payments for any claims. Elliot Spitzer barged into town with guns blazing, not because of the bears but likely because of political pressure, and, well, fell off a cliff due to some, hmm, personal problems. Eric Dinallo seems to be cool-headed but it remains to be seen what comes out of any of this.

Most Important Lesson I Learned This Year

Martin Whitman summed up earlier in his letter a lesson for investors:

One of the important lessons from the Bear Stearns debacle for TAVF is to avoid owning common stocks of companies where the businesses need to have relatively continuous access to capital markets in order to survive as going concerns. It is also important to avoid common stocks of companies where the customer base can be lost because of a rumor campaign and where Third Avenue would suffer losses were there to be a run-off of the business.

I never understood what it means to own a company that depends on the capital markets. After owning Ambac and following the Bear Stearns case, I now know. Although Ambac doesn't really rely on the capital markets (only time was with its dubious tactic of trying to raise capital to preserve its AAA rating), it is very close to the description above.

Contrast Bear Stearns with Buffett's American Express in the 60's. Even though American Express was supposedly on the verge of bankruptcy and the media was all over it, the customers never fled the company. In contrast, Bear Stearns collapsed without even missing a single payment simply because its customers fled.

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10 Response to Third Avenue 2nd Quarter 2008 Commentary by Martin Whitman

June 14, 2008 at 5:43 PM


I think Whitman means with his "zero coupon bond" comment that in a reorganisation scheme investors in the fulcrum security may not get their regular interest but will see their investment, with interest, paid in full, either in cash once the reorganisation is complete (a true zero coupon bond that pays the accumulated interest at maturity) or as stock in the reorganised company.

Whitman seems a bit annoyed at the succes of the bear raiders. Possibly because his fund is sitting on substantial unrealized losses mainly due to continued well-publicized attacks on companies he holds (monolines anyone?). Fortunately the monolines are save from sudden capital withdrawals. If they could suffer from a " bankrun" they would be toast already.

Whitman does not seem to like the bear raiders very much and I agree. It is very well to short a stock, this helps efficient pricing. It is not well however to make good on the short through rumour campaigns and attacks based on bogus analysis. On the bull side pump 'n dump schemes are (rightfully) illegal. I can't help but think the increasingly shrill bearish rhetoric on much of the financial industry is largely a reverse pump 'n dump (short 'n shock?).

Not all speech is or shold be free. Advertising a $50.000,- reward for somebody's murder is sollicitation of a crime and illegal. Almost every country has limits on insulting and slanderous speech against persons. Damaging companies through malicious rumours in order to profit from the intended drop in stock price can have very damaging consequences not only for shareholders of the companies involved but also for employees and their families. And if the damage is widespread enough the overall economy can suffer. Arguably, there should be a way to limit rumour mongering to power a bear raid. The hard part is to do it in such a way that negative analysis (backed by facts please!) remains in the clear.

As to your question what sectors I like. Well, the financial sector appears to be a very rich unting ground for bargains. Back here in the Netherlands all the major bank/insurers (all four of them) have dividends above 6% (8,5% for Fortis) with payout below 40% of cash flow and profits holding up well. In the US the monlines and similar companies look real cheap. Several banks start to look like bargains as well alhough I will not buy them for fear of a bankrun. If the monolines recover fast and hit fair value before the banks begin to recover banks might be a place to get an " afterburner" to returns from this financial crisis. I think the financial sector is really the place to be when looking for supercharged returns for the next 2-3 years.

On this side of the pond retailers, particularly those peddling consumer durables are worth a closer look. Several sport high dividends, low price to book and low p/e coupled with steadily growing earnings. It looks like the market has priced in a severe recession while the local economy is stubornly refusing to stop growing. If anything, growth seems to be speeding up.

I am rather bearish on US retailers as I suspect the US consumer will have some very tough years ahead with a huge debt overhang and stagnant or decling real incomes. The US economy overall will do quite well I think, but on the back of a surge in exports and that's useless to retailers.

With all due respect to Whitman and Buffet I think they are way early calling a bottom in US real estate. The sector will probably be struggling with an enormous supply overhanf years after the financial crisis has been practically forgotten.

US companies with strong exports and/or export opportunites could be worth a look. This applies particularly to basic materials and consumer staples. With the decline of the dollar exporting from the US has become a good proposition and companies that can benefit from this can expect substantial increases in earnings.

I have recently taken a look at a bunch of companies that provide MMORPG games in China (GA, PWRD among others). They look like a good ticket when shopping for growth at a reasonable price. They grow very fast (20-50% p.a.), have real cashflow and lots of it yet trade at 12-18x trailing earnings.

Remaining on the long side, if India and China continue the recent selloff I will consider buying, probably in the form of a mutual fund. Both countries have excellent prospects for relatively rapid growth so if stock can be bought at reasonable valuations good returns are to be expected.

Shorting select comodities, especially oil, and their producers while not for the faint of heart is also something I am considering. Fairly longdated puts would be the way to do it I think to avoid excessive downside risk. This is maybe not a "value" strategy but it is certainly contrarian and I think excellent returns can be had.

Basically, oil can be produced in vast quantity for $70/barrel max. At that price point oil shale and deepwater operations are profitable (and coal conversion too I think). Consequently, oil prices above that level will inevitably be pulled down as supply increases. Improving technology and economies of scale will likely push production costs down.

So, I am thinking of going long US financials but not banks for now, avoiding everything else US, long European retail and financials, long India/China if they become cheap enough soon and short commodities esp. oil.

And to cap another long post, could you give a more complete outline of your own ideas? You have posted some (US retail, Japan) but I am interested in hearing more.

June 14, 2008 at 11:32 PM

He never quite explained why in the case of the monoline insurers the common stock would be the fulcrum security. I can understand a senior bond w/ 1st claim in bankruptcy would be a fulcrum security. Why would a common stock, being the last in priority and 1st to abe diluted, would be "fulcrum".

Bear Stearns got in trouble because of its leverage. When funds leverages their equity 32 times, they only have themselves to blame for the vulnerability to runs.

To Whitman's credit, he realizes he needs to avoid situations where his investments get tangled with shortsellers.

I shorted Bear in 2007 and made a little money, but when I tried to short it again in early March, my broker didn't have any stock to borrrow for shorting, so I stayed away from it.

People give shortsellers way too much credit and blame. Shortsellers occupy an investment ecology that is highly darwinian. In my opinion, Einhorn, Ackman, et al are quite reckless in advertising their short positions, which is a recipie to invite squeezes. But I'll tell you why they are so publically confident: when they have the secular macro trend going their way, it's a good bet to bet on the demise of i-banks, monolines, badly run retailers, or anything that Bill Miller owns.

June 15, 2008 at 5:10 AM


First of all, almost all businesses are leveraged these days and all things considered so are households (mortgages anyone?). Bear was quite heavily leveraged but not excessively so by Wall Street standards and less heavily leveraged retail banks are vulnerable to bankruns to. Yet we all survive our leverage usually.

During the Great Depression thousands of banks went bust and the irony is that going bust or not had nothing to do with the health of their balance sheet. When rumours started to swirl a bank was usually done for, no matter how good it's assets. Weak banks meanwhile could often survive provided no nasty rumours popped up. Merril Lunch, Goldman Sachs, Lehman are all vulnerable to the kind of campaign that sank Bear. Even at 2x leverage you are done for if your access to credit suddenly gets pulled.

I have nothing against shortselling but find the combination with highly publicised rumour campaigns fishy. And only the "classic" shorting (selling borrowed shares) is really dangerous. With put options or CDS contracts shorting can be done at little risk. Ackman for example would have been bankrupted years ago if he had tried to do a " classic short" on MBIA. He used primarily CDS contracts instead, reinforced with some options and could last for years. Incidentally, all those years he found himself in the position Whitman (and Sivaram and myself) are in now. He was holding a position that the market had turned decisively against, or so it seemed. Ackman's short positions yielded nothing and must have caused enormous unrealised losses as CDS spreads on MBIA narrowed. Ackman's position has of course been vindicated if not for the reasons he initially took the position for.

I'll also hazard a guess why Whitman says the common stock is the fulcrum security in Ambac/MBIA. Basically any unwind of these companies will take many decades and as there is no shortage of cash there is no problem in paying bondholders. The common stock therefore has control and wil keep it. (As far as I get it, Whitman's definition of the fulcrum security is that it is the security that can exercise control in a reorganisation/unwind of the company. Whitman always buys enough of it to have a seat at the table). Given that the common stock has control there is nothing to stop the holders of that common stock from draining all cash out of the company as long as regulatory minimim is met. And as Ackman noted correctly the regulatory minimum is decided largely by the companies own estimate of losses. Also, any sort of reorganisation will need approval by the common stock. That makes it the fulcrum security.

You really don't like Bill Miller do you? May I ask why?

June 15, 2008 at 11:19 AM

Good discussion guys. It's always good to see deep posts with divergent views. I'll try to respond a bit later if I get some time; I am writing some blog entries here with some ideas running in my head :)

June 15, 2008 at 11:05 PM

<< Bear was quite heavily leveraged but not excessively so by Wall Street standards and less heavily leveraged retail banks are vulnerable to bankruns to. Yet we all survive our leverage usually.>>

In the spirit of John McEnroe's retort.....You can't be serious about the above paragraph!! But it doesn't sound like you're pulling my leg, so I'll just have to take why you wrote at face value.

What you wrote about leverage reminds me of what Nassim Taleb said about the turkeys (in the context of faulty inductive reasoning) -- they (the turkeys) tend live, and think they live, splendid lives up until the night before Thanksgiving.

So, yes, if you use leverage, eventually SOMETHING WILL GO WRONG, but maybe not immediately.

As to my thing with Bill Miller, aside from the fact that he has an appalling lack of respect for risk, I guess I will have to answer with the following paragraph taken from the excellent book "What I Learned Losing A Million Dollars" by Jim Paul and Brendan Moyniham:

"Sucess can be built upon repeated failures when the failures _aren't_ taken personally; likewise, failure can be built upon repeated successes when the sucesses _are_ taken personally.....Persoanlizing sucesses sets people up for disasterous failure. They begin to treat the successes totally as a personal reflection of their abilities rather than the result of captializing on a good opportunity, being at the right place at the right time, or even being just plain lucky. They think their mere involvement in an understaking guarantees success.....This phenomenon has been called many things: hubris, overconfidence, arrogance."

June 15, 2008 at 11:09 PM

If you read Bill Miller's quarterly commentary, basically you can boil down his investment philsophy down to, "hey, it worked in the early 90's, it's gonna work again this time around, so just Trust Me."

If the remaining investors in Legg Mason Trust, upon reading his quarterly commentaries, still decide to stay with him, then I guess they deserve each other.

Not me. He doesn't deserve a dime of my savings.

June 15, 2008 at 11:49 PM


Similar to what ContrarianDutch is saying, I think the shares are considered the fulcrum security for the monolines because the bonds are a small portion of the capital structure of the holding company. Although the declining market cap makes the bonds look somewhat large, the probability of defaulting on the bond is low. Most of the bonds, if I recall, are something like 100 year bonds so there is little risk of a need to retire them (or refinance them) any time soon.

In contrast, for most other businesses, debt will be sizeable and companies often default on their debt payment or can't retire/refinance them upon maturity.

Finally, if the holding company goes bankrupt (this will happen if the insurance company doesn't pay any dividends to the holding company) then there is little benefit to owning the bonds over the shares. Unlike a typical business, the holding company is a shell company with basically no assets (maybe some furniture or something useless). There is very little benefit to owning the bonds of the holding company in my opinion (if things are good, shares will dictate what the company does; if times are bad, both shares and bonds of the holding company are worthless).


Synchro, Bear Stearns did not collapse solely due to its leverage. I have to double-check but I think some competitors like Morgan Stanley have higher leverage. Bear Stearns collapsed due to a run on the bank. The 30x leverage exacerbated the run on the bank but even if its leverage was, say, 15x, I think it would have collapsed. Remember, Bear Stearns was nowhere near missing a payment or defaulting on its debt. It was all rumours.

The problem with Bear Stearns, on top of it being a big secrutizer of subprime mortgages is that its so-called prime brokerage division, which caters to hedge funds, was a big chunk of its business (check out this The Economist article). When hedge funds got scared they just fled Bear Stearns. Hedge funds are less loyal customers than the average citizen (retail).


Synchro, do you really think Bill Miller was lucky for, what, almost 15 years? Shouldn't you give him the benefit of the doubt given that he did OK through two big bear markets (1990, 2000)?

Would you say Warren Buffett has a lack of respect for risk when he buys Washington Post which dropped 50%+ and kept dropping for almost an year after he first started buying (from what I understand)? I'm not putting Miller in Buffett's class but just wondering what you think is appropriate risk management? Maybe your idea of proper risk is to follow market consensus and try to stay close to the market (even if you underperform for your whole life)?

June 16, 2008 at 12:34 AM


Your oil short consideration may pay big dividends but be careful. Bubbles can go much higher than anyone thinks. I think you are onto something (even a commodity superbull like Marc Faber thinks oil may drop to $80, although he expects it to do well over the long run) but it's a risky game.

I see merit in most of your proposed strategies. The areas that I disagree are the following:

I don't like your US basic materials sector idea. I'm not entirely clear on what companies you are looking at but if these are commodity producers, they may be overvalued and vulnerable to a slowdown. If they are slightly higher up on the value chain and are exporters, their valuations may be fair to high. It depends on the companies but I took a look at companies like G.E., Emerson, Catepiller, etc, and I don't find them cheap. I think the export-to-emerging-markets theme is priced into most stocks.

Consumer staples are probably the best industry to weather any sort of storm. But I feel that the valuations are way too high. Most of them trade with P/Es around 16 to 20, with low, but reliable, growth rates.

Funny that you mention MMORPGs because I was looking at them 3 or 4 years ago. I was considering Gravity (Korean) and Shanda (Chinese). Boy, did I miss out on Shanda (but Gravity would have been a total disaster). My strategy has changed and I don't look at hyper-growth companies like that anymore. Although valuations for some of those companies looks attractive, they are pinned on high growth and they have no reliable moat (as Buffett would say). Who knows if they get displaced by some new entrant?


As for my investing strategy right now, I don't have any concrete thoughts. I'm trying to figure out if inflation is going to be a permanent problem in the future. Although I don't try to rely excessively on macroeconomics, I am scared of valuation compression.

I have been looking at all the beaten-down areas. I am most bullish on America and Japan. Those are two countries that have underperformed for the last few years and can withstand economic problems. In USA, I am looking at the industries that have done the worst in the last few years. These include newspaper companies, Canadian forestry stocks, financials, retailers, building material suppliers, and some technology and industrial stocks. I haven't narrowed it down to anything other than the following: Sears (SHLD) in retailing; Owens Corning (OC) or USG (USG) in building materials; Black & Decker (BDK) in industrials.

As for Japan, I have been trying my best to do some research and am not happy with what I find. Most companies have low ROE and are poorly run. I have focused mostly on brand name industrials with world-class products (these should be able to handle any downside from Yen appreciation--a real threat). I have also been trying to find some real estate or a company producing branded consumer products (no luck so far). Given the sell-off in the last few months, I have started to look at Japanese automobile and recreation vehicle manufacturers such as Toyota, Honda, Mazda, Suzuki, and so forth. But the ones that I like right now are the industrial companies such as Makita, Fanuc and Yaskawa (these produce industrial robots, motors, and factory automation tools). My reason for looking at these industrials is similar to your reason for looking at export-oriented US companies. Japanese companies have the unwinding of the Yen carry-trade as a headwind but they are world-class leaders who will be able to pass on any cost increases and have relatively low valuations.

I am also taking a look at India, China, Vietnam, Hong Kong, and so forth. I think valuations are still too high in most of those countries. I also want to wait and see if there are some political crises (usually emerging markets have political problems whenever inflation is high or the economy slows.) I am waiting for a collapse in those countries but if that never happens I'll likely miss out on their future boom (I don't mind that though; I would rather miss an opportunity than end up paying too much).


I suspect that you are more of a growth investor than me. For instance, I don't look at GARP at all. I may end up catching more falling knives but I tend to avoid anything with, say, a P/E ratio above 15 (but for cyclicals it's the opposite). I'm just a total newbie and not sure if this is a good thing (I'll miss out on a lot of good companies and future stars) but that's my style right now.

June 16, 2008 at 10:09 AM

I guess the quote from Jim Paul and Brendan Moyniham didn't really sink in, I'll be more explicit: have an exit strategy other than "I'll know when I am wrong when the price goes to zero."

There are a zillion ways of making money. I don't fault Whitman and Miller's way to making money. In fact, I track what stocks they own closely. I suspect when the trend turns, I'll be joining them. But I question their way of handling their losses.

June 16, 2008 at 10:18 AM

I don't recall Bill Miller "did OK" in the 2000~ 2003 bear market. Oh, that's right, IN HINDSIGHT looking back from 2008, he did ok early in the decade. I guess averaging down works!

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