I have been meaning to write this post for the last few days… and have finally found the time.
At the beginning of stock market decline in Aug, I was about 7% stocks, 8% bonds and 85% cash… today I’m about 17% stocks, 8% bonds & 75% cash…
A lot of the blogs/comments I have read over the past two years and particularly during the stock market decline in Aug/Sep made me really realize the virtue and reward of staying out and staying put…
Knowing when to sit out and watch the market from the side lines is just as important as finding good trade setups and investment ideas… if you don’t find any, be patient, read/study, analyze and pound when the time is right… I have this much from many bloggers particularly the folks on Stocktwits.
Sitting out has tremendous benefits:
- I didn’t not feel the need to look at my portfolio 3 times a day even after the market dropped 10% and was dropping more… more time to do things I want to do
- I was able to consume and more importantly comprehend whatever I read, be it MSM or the very informative, educational and mostly unbiased financial/econo-blogosphere – it is natural to comprehend less when you are worried.
- I had all the time in the world to read about topics I was interested in rather than looking for topics/posts that would make me feel better and confirm my supposed rationale for holding stocks
- I could analyze a trade or an investment idea with fewer inherent biases
Sitting out is one of the hardest things to do possibly because of the fear of missing out… overcome the fear of missing out and you will have a clearer mind to analyze more opportunities ahead.
In case you haven’t noticed, the TSX is down 5% YTD and 10% from April 2011 highs… which puts it squarely in a typical correction territory… while Bonds (as represented by XBB – DEX Universe Bond Index) are up 2.5% and 4.25% for the same period as illustrated by the TSX/XBB weekly charts
Here is look at the bond performance over the past decade… and today XBB gaped up!
The question is not how low can stocks go but rather how much higher can bonds go?
Bond prices are inversely related to interest rates i.e. if bonds are rising then interest rates/yields are falling… for all intents and purposes, XBB reflects all rates along the yield curve i.e. short and long term rates…
short term rates are above their record lows but 1% is still low historically
10 yr GOC yield is at 2.8%… which is ~10 bp higher than the most recent low of 2.68% from a year ago
So there is room for bonds to go up further especially considering the Euro area weakness… but will we see new lows in 10-year yields?
(in case you are wondering why the 10-year yields… the trend of 10-year yields is usually considered a good barometer of future economic growth)
I have liked coal for the last couple years despite of the global warming/green energy/fierce environmental protection backdrop… for the foreseeable future I see demand for coal to keep rising regardless of what happens with the renewable energy sources.
Why I feel that way?
Two stats from World Coal
Coal provides 27% of global primary energy needs and generates 41% of the world’s electricity
Approximately 13% (around 717Mt) of total hard coal production is currently used by the steel industry and almost 70% of total global steel production is dependent on coal.
If you prefer to view graphics like I do, here are some key figures from IEA’s World Energy Outlook 2010
So… if you are still not convinced, too bad J
Moving forward, I plan to analyze some coal stocks and present my analysis here.
Grande Cache Coal (GCE.TO)
I’ll start with the easy technical stuff for Grande Cache coal – a metallurgical coal miner (i.e. coal used for steel making)
- The stock has broken out of the recent downtrend channel (blue) and closed above the 50, 100 & 200 day moving averages on reasonably high volume
- Green lines are support, Red lines are resistance and there is immediate resistance around 10.5, then at 11 and 12
In the next post, I will delve in to the fundamentals of GCE
Update: Right after posting this article I stumbled upon this piece from FP via Alphaville. Trust me I’m not looking for an opinion that confirms my thesis (confirmation bias) quite the contrary. Here are the salient points from the FP piece:
According to official data, Chinese investment in coal was about the same as its investment in oil, gas, and scientific research combined. The investment in coal at home was larger than the PRC’s outward investment in all non-bond assets — all energy, all metals, and so on — in 2010.
From 1980-1996, coal consumption growth was about 5 percent annually. From 2003-2009, under leaders Hu Jintao and Wen Jiabao, it was over 13 percent annually.
Coal previously accounted for less than 70 percent of Chinese electricity use; now it is over 80 percent.
CFA Level 2 – Equity Investments; Study Session 11, Reading 38 in 2011 curriculum/Reading 36 in 2010.
This reading introduces some of the basic concepts of analyzing equity investments. I’m excluding the theoretical parts and will focus mostly on bits of interesting corollaries…
A global industry analysis should examine:
- return potential evidenced by demand analysis
- value creation
- industry life cycle
- competition structure
- competitive advantage
- competitive strategies
- co-opetition and the value net (yes…co-opetition is a word)
- sector rotation
- risk elements evidenced by market competition
- value chain competition
- government participation
- cash flow covariance
Global financial analysis involves comparing company ratios with global industry averages. In this context, DuPont analysis uses various combinations of the tax retention, debt burden, operating margin, asset turnover, and leverage ratios.
Extended Dupont formula for Return on Equity (ROE):
Franchise Value or PVGO
Intrinsic P/E can be broken down into tangible P/E and Franchise P/E. Tangible P/E assumes constant earnings and Franchise P/E is the present value of growth opportunities divided by next year’s earnings i.e. PVGO/E. Think of tangible P/E as the average industry growth rate and franchise value as the additional growth that is unique to the company/industry.
r = required rate of return
b = Retention Ratio = (1 – Dividend Payout Ratio)
Analyze Effects of Inflation on Valuation
Inflation affects historical inventory and borrowing costs on reported earnings, as well as the inflation tax reflected in capital gains taxes (i.e. you purchase an asset today which increases in value equal to inflation rate, you decide to sell the asset and incur capital gains tax… you actual are losing capital because the rise in asset value is due to inflation).
To analyze the effect of inflation on a firm’s valuation, you must estimate the degree of inflation flow-through denoted by λ in textbook.
A company/industry with high inflation flow-through rate will be valued more because it can pass the higher input costs to the consumer and maintain profit margins.
Herfindahl Index (we have seen this before in Corporate Finance)
This index is used to measure competition in an industry. The US Department of Justice uses this index to measure industry concentration. The formula is straightforward…
I doubt that Canada’s Competition Bureau uses this index considering the prevalence oligopolistic industries in Canada (banking & communication are two big ones)
TSX – perhaps May arrived earlier this year!
Levels to watch
· 13100 (61.8% Fibonacci retracement)
· 12325 (38.2% Fibonacci retracement)
The US dollar index (trade weighted measure against other currencies) is down about 3% in 2011. How does this affect earnings of US companies? US companies can be broadly classified in to two categories: those that do 100% of business is in US and in USD and those that do a significant share of their business globally… it is the second category of companies that are most affected by currency fluctuation…
How does USD depreciation affect stocks?
When the dollar is rising, US companies that do most or all of their business within our borders stand to benefit, while US companies with large amounts of revenues outside of the country lose out. The opposite occurs when the dollar is declining — companies with large amounts of international revenues benefit at the expense of the domestics.
If the above is not intuitive, visit my earlier post here.
As shown in the second chart below, the average YTD performance of stocks in the decile with the largest percentage of international revenues is 7.68%, which is by far the best performing decile. The average YTD performance for stocks with no international revenues is 3.09%. This performance is inline with what one would expect given the dollar’s decline.
Loosely speaking, about 3-4% of the 7.68% rise in the top performing decile can be attributed to currency depreciation and the rest to the general market rise…
Going forward, if you expect the dollar to continue its decline, the stocks with large amounts of international revenues should continue to outperform. If you expect the dollar to reverse course and head higher, the stocks with little or no international revenues should start to pick up.