Being Cheap In A Rich Market / The New “Plastics” / The Force Is With This One

Being Cheap In A Rich Market

 

So here’s the conundrum as you look to decide what to put in your holiday financial shopping cart in preparation for the big ‘20: we have a rip-roaring economy with strong jobs numbers and very low unemployment, we have a Fed that’s on hold until we get sustainable inflation over 2% (so far ephemeral), we have a thawing of global trade tensions that have arguably been the main drag on global growth and certain segments of the US economy – what’s not to like?

The problem is that the stock market anticipated this well in advance (you might have too if you’ve been reading Kaoboy Musings 😉) and has already priced in “rational exuberance.”  With the market pricing in close to 20x forward earnings, stocks are not cheap, but I would argue that they’re not “irrationally exuberant” either as they were in the late 90’s.  That said, with a year-to-date performance of around ~30%, the heady market makes the contrarian in me wonder whether even the Anti-Oracle I call the Bearded Hamster would be reversing his parting  “get-out-of-the-market” call right about now (see Kaoboy Musings 16).

Again, the conundrum: if you believe, as I do, that the economy still has legs and may even be re-accelerating now with trade tensions on détente, what do you buy if you’re a cheap bastard like me and don’t want to pay market rates for forward earnings but don’t find sub-2% bank interest rates appealing?

What if I told you that there was a sub-sector of the market that has never been this historically cheap and that the “widgets” these companies make are “must-haves” for the global populace?  What if I told you that the reason why this sector has been so battered over the last few years is because of a confluence of factors that have led to a temporary oversupply of these “widgets” but that these factors are now starting to align in the opposite direction and are likely to lead to a supply crunch of these “must-have” widgets?  What if I told you that many of the companies in this space are now generating free cash flow even as they’ve significantly curtailed future “widget” production?

 

 

The New “Plastics”

 

If you haven’t figured out what this sector is yet (and haven’t read the last several Kaoboy Musings), I’m going to quote Mr. McGuire in The Graduate as he takes young Ben (Dustin Hoffman) aside and gives him career advice: “I just want to say one word to you. Just one word.”  Nope, I’m not talking about “plastics” – I’m talking about “oil & gas.”

I attended an oil & gas conference in Houston this month and met with 14 companies, mega-cap down to small-cap, up and down the oil & gas food chain as well as many investors and analysts in this space  – I was surprised that so many of us “endangered species” are still alive!  Nevertheless, I have come back with some new micro and macro insights as well as more conviction in my thesis than ever before.

Let’s start with a chart that shows you in stark relief what oversupply in oil & gas has done to this sector relative to other sectors within the US stock market:

This chart shows 11 sub-sectors of the market as well as the S&P 500 (in white), normalized to the same starting point exactly 5 years ago.  The top performing sector in green is large-cap tech.  The massive underperformer in red is – you guessed it – oil & gas.

In past missives, I’ve outlined some of my bullish arguments already, so this time I’m going to start with the opposite, devil’s advocate, opinion as outlined in this article:

https://www.bloomberg.com/news/articles/2019-12-22/oil-s-2019-milestones-tell-decade-s-story-of-energy-abundance

The article makes several key points:

  1. The US shale revolution of the last decade has given us a global surplus of oil & gas “widgets” that have not only cushioned the world against unprecedented geoplitical risks but have also led the US to become a net exporter of oil & gas and surpass Saudi Arabia in production.
  2. OPEC no longer has the market power it once did, and its cuts have only stoked shale competition.
  3. Even as shale growth is slowing, other non-OPEC sources of growth are “springing to life.”
  4. Demand for oil & gas is predicted to stall out by the end of the next decade due to EV adoption in an to forestall climate change.
  5. In an era where the words “oil & gas” have become politically incorrect, financial players are increasingly embracing ESG (Environmental/Social/Governance) investing standards and shunning this sector.

I’m going to address each of these points, one-by-one:

1. The US shale revolution has indeed decoupled oil, once a geopolitically semsitive commodity, from even extreme events like the attacks on Abqaiq in September.  In the past, a shock event that takes 5.7 mm barrels/day off-line would’ve resulted in triple-digit prices; this time, we had a muted and brief spike that faded almost immediately after the Saudis assured the world that “everything was fine” and that full production would be restored within a month.

Several oil analysts I have met have called bullshit on the Saudi “everything is fine” narrative and think that they drew down more than 30 mm barrels from internal storage and that the recent voluntary Saudi “overcompliance” over and above the increased cuts is nothing more than a “face-saving” way to rebuild their reserves.  Given the recent Aramco IPO, Saudi credibility as a reliable supplier of oil is paramount, and I buy into this thesis that the additional cuts weren’t a magnanimous “gift” to US shale (as the Saudis suggested) but a necessary action to replensih their own lost supply.

Despite what Saudi Arabia claims, many analysts believe that true spare capacity (short-cycle capacity that can readily be brought on within 3 months) in OPEC is less than 2 mm barrels/day, or roughly 2% of global daily demand.  That is a razor-thin margin for error no matter how you slice it.  The one big caveat in all of this is that Iran has about 1.8 mm barrels/day of capacity that is effectively shut-in due to the sanctions and isnot included in this estimate of spare capacity; if sanctions were lifted for whatever reason, the additional supply would negate much or all of the OPEC cuts. 

2. The bigger issue of OPEC’s loss of influence and the US resurgence as a major world oil supplier rests entirely on the US “shale miracle” of this decade, which was enabled by a unique confluence of factors including:

    • Plentiful domestic shale deposits
    • Technological advances in horizontal drilling and hydraulic fracturing
    • Abundant water supply (necessary for frac’ing)
    • Economic and political framework of mineral rights that incentivizes drilling and exploration
    • Plentiful access to cheap capital that enabled not just runaway drilling but also infrastructure buildout
    • Abolition of the export ban that allowed US producers to access global markets

Not only do I believe that this alignment of factors is unique to the US and not replicable in other parts of the world that do have shale deposits but lack many of the other ingredients, I think several of the aforementioned factors are beginning to reverse here, namely:

 

  • Most US basins outside of the Permian have already peaked, with “Tier 1” acreage already drilled out and “Tier 2” locations only half as productive according to some analysts.  As a result, annual decline rates are ticking up from mid-30%’s to low-40%’s, which means that producers need to drill more just to keep production flat.  To show how dangerously dependent the world is on the Permian Basin, this small slice of Texas accounts for 2/3 of US shale growth, and US shale represents about 2/3 of total non-OPEC growth going forward.
  • Improvements to well productivity and drilling times are starting to plateau; in other words, technological improvements are likely to be incremental going forward as opposed to be revolutionary.
  • Plentiful access to cheap capital has come to an end, given the value destruction in this sector over the last 5 years.  Exploration & production companies are battling a two-front war, with capital markets demanding free cash flow and return of capital while their service providers are barely earning their cost of capital.
  • The result is that most prognostications of US production growth are going to fall way short of expectations.  Some of the folks I’ve spoken to think that US production growth for 2020 will be closer to 400-700k barrels/day vs. “consensus” expectations of 1-1.5 mm barrels/day of growth.

3. The point about non-OPEC growth “springing to life” is backward-looking.  Outside of US shale growth and OPEC+, the last of the big projects are coming on-line now (including Brazil and Norway) from the 2010-2014 vintage of $100 oil-inspired wave of long-cycle capex (these projects have 5-7 year lead times), and this has already been priced into the market.

Looking at the chart above, you can really see why the last 5 years have been characterized by an era of oversupply.  The supply from the projects put in place during the 2010-2014 era hit the market at the same time US shale production was going bonkers.  Looking forward, no money has been spent on these long-cycle projects during this recent period of low oil prices, and that drought projected forward 5-7 years is about to hit us at the same time US shale production is rolling over – this is literally the opposite dynamic of the last 5 years.  If I were a betting man (and I sure as hell am), I’d bet that the next 5 years look more like 2010-2014 than 2015-2019.

This article spells it out: https://oilprice.com/Geopolitics/International/The-Dark-Outlook-For-Non-OPEC-Oil.html

 

4. Global oil demand has been growing 1.25 mm barrels/day on an annual basis, consistently for the last 5 decades, and only 7 of the last 49 years since 1970 have seen negative blips in demand, according to Art Berman of Labyrinth Consulting Services (see Kaoboy Musings 15 where I included Art’s full deck).  The notion that the “EV Revolution” is going to make this time different and cause forward demand growth to plateau or even decline presupposes the following:

 

    1. That EV adoption will continue based on economics alone.  Evidence suggests the contrary as sales have slumped along with an end to subsidies: https://oilprice.com/Energy/Energy-General/Chinas-Electric-Vehicle-Bubble-Has-Popped.html
    2. That EV adoption will not encounter its own issues with respect to lithium and cobalt mining/disposal externalities.  The whole focus on “ESG investing” seems disingenuous to me when it chooses to focus on one variable (carbon emissions) and disregard everything else. Witness: https://oilprice.com/Energy/Energy-General/The-Human-Cost-of-the-EV-Revolution.html
    3. On a current global base of 1.4 bn vehicles, EV sales of 2 mm in 2018 are inconsequential.  Taking this number up 10x by 2030 (as some manufacturers have forecasted) will still only result in 60-90 mm total EV’s out of an even higher base of ICE (internal combustion engine) vehicles.  If we then factor in the fact that 40% of annual car sales currently are SUVs which consume a lot more gasoline than cars, the number of EVs on the road just won’t matter at all to oil demand.
    4. The rapidly industrializing emerging economies of China and India are energy-starved and are far likelier to support urbanization initiatives that are viable with the current infrastructure as opposed to waiting for the EV revolution.  The analogy of “going straight to wireless” in the realm of telecommunications just doesn’t hold up in this case. 
    5. The whole ESG focus revolves around the debate around climate change and the focus on cutting carbon emissions.  While I’m not going to get into a whole political debate about this topic here, I have been reading extensively on this topic and engaging with several experts in the field.  In short, while there is no denying that the climate is indeed changing (and it has for the entire 4.5 bn years of Earth’s history), the science does not appear to support Anthrogenic (man-made) Global Warming (AGW).  This is one of the most comprehensive papers I’ve come across that suggests that the focus on curbing CO2 emissions is tantamount to “barking up the wrong tree,” as Professor Giengengack, Chair Emeritus of UPenn’s Earth and Environmental Sciences said to me.

Here is the link to the paper: https://wryheat.files.wordpress.com/2019/04/climate-change-in-perspective-2019.pdf

As an investor and believer in free markets, I believe the capital markets tend to ferret out the most viable and economic solutions in the long term – capitalism culls out the weak in Darwinian fashion. 

 

The following regression is from a site called https://wattsupwiththat.com and shows a very clear correlation of electricity costs with renewables adoption, i.e. the less you depend on hydrocarbons, the more expensive your electricity is.  Note that Germany and Denmark, the poster-children of renewables adoption, have electricity costs that are 3x that of the US.

Bottom-line: I have very high conviction in this oil & gas thesis over the next several years, but this sector is not for the faint of heart.  The two biggest risks are global recession and a removal of Iranian sanctions, neither of which I place high probability on. 

There are many ways to play this thesis: through the commodity itself, through oil & gas weighted ETF’s like the XOP (exploration and production companies) or OIH (oil services), or through individual equities (which I would not recommend unless you do your own homework and are comfortable with idiosyncratic company risk).  In the name of full disclosure, outside of my sizeable bets in GSE preferreds, individual oil & gas stocks comprise (by far) the biggest chunk of risk assets I have in the securities markets.  I own FANG, VNOM, NOG, FLMN, ET on the public side and Birch Resources on the private side.

 

The Force Is With This One

 

Not only are the holidays upon us, Star Wars season is once again here as well.  I officially submit my review of Star Wars, Episode IX: The Rise of Skywalker for your perusal.

As a long-time Star Wars fan, I had great hopes when Disney acquired Lucasfilm in 2012.  Seeing what they did with the Marvel franchise, I naturally extrapolated similar success to what they might do with the Star Wars franchise, supercharged with the might and muscle of Disney behind it.

When the greatly anticipated Episode VII: The Force Awakens came out in 2015, while I was disappointed by the fact that the story arc resembled the original Episode IV: A New Hope very closely, I was still entertained because the director, J.J. Abrams, introduced some intriguiing new characters and plot elements that invited speculation (something the Star Wars fan community loves to do).

Along came Rogue One in 2016, the prequel to Episode IV: A New Hope.  I loved this movie and was lucky enough to attend the red carpet premiere, replete with a full-scale X-Wing fighter on Hollywood Blvd -- the fanboy in me was in heaven!  I remember thinking to myself that George Lucas made a huge mistake selling too cheaply and that Disney would usher in a new Star Wars Golden Age. So far so good!

Then came Episode VIII: The Last Jedi in 2017 – and my Star Wars dreams imploded faster than Death Star 2 over Endor.  Inexplicably, the director Rian Johnson, systematically shut every plot door that J.J. Abrams opened in the The Force Awakens and simultaneously discarded every bit of fan-revered “canon” in one fell swoop.  It’s as if he systematically hunted down and destroyed everything fans loved about Star Wars, a la “Order 66”!  Honestly, forget about it being the worst Star Wars movie by far, it might’ve been one of the all-time worst movies I’ve ever seen in any genre, and Rian Johnson deservedly earrned his own entry in the Urban Dictionary as a result: https://www.urbandictionary.com/define.php?term=Rian%20Johnson.  I could just picture George Lucas LOL’ing, knowing that forlorn fans like me would beg him to come back at any price – even with Jar Jar Binks in tow!

 

Meanwhile, as you can see below, the “official” critics gave it a 91% rating on Rotten Tomatoes – Jedi mind trick by Disney?  Fans like me crushed it with a 43%, which I thought was generous (I would have rated it 1 out of 10).

 

 

So when a neighbor invited me to the “Friends & Family Pre-Showing” of Star Wars IX: The Rise of Skywalker at the El Capitan on December 16th, you can imagine my level of indifference.  For the first time in the history of Star Wars films, I had seriously considered waiting for this one to hit Blu-Ray before seeing it, but since it was free, I figured “why not”?

 

Imagine my surprise when halfway through the movie, I’m not only not hating the characters any more, but I’m actually enjoying the movie!  J.J. Abrams now has my undying respect as a Jedi Master for levitating this wreck out of the swamp – not only did he fix all of the issues that Rian Johnson created, he managed to do so in a way that almost allows you to think that some of the gaping plot holes in The Last Jedi were done on purpose.  Almost.  There were still a couple moments that made me cringe (watch it and you’ll know what I’m talking about), but not enough to keep me from seeing it a second time this weekend with my family.  After Round 2, I actually liked it even more and would actually assign an 8 out of 10 for this one – I even rank it slightly ahead of Rogue One, and that’s saying a lot

Note, however, how wrong again the “critic consensus” is.  If you’ve been reading my Kaoboy Musings, you know how much I value contrarian thinking.  Let this be no exception.  Don’t trust the critics – go see The Rise of Skywalker.  J.J. is a Jedi Master, and this is the finale you’ve been looking for!

May The Force Be With You, and Happy Holidays!

 

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About

Kaoboy Musings is a private distribution list/blog that I created to encourage dialogue regarding the economy & markets, geopolitics, investment ideas, and life in general. I have a passion for the markets and investing, and even though I no longer accept investor capital, I try to keep current on global events and opportunities and remain active in the markets.  I’ve always found that writing my ideas down, sharing them with smart people, and encouraging two-way discourse and devil’s advocacy is often the best way to validate or invalidate a thesis and stay mentally flexible.

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Akanthos Capital Management, LLC (“Akanthos”) is an exempt reporting investment adviser with the state of California.  This message is for informational and professional purposes only, cannot be distributed without express written consent, and does not constitute advice, an offer to sell, or a solicitation of an offer to buy any securities and may not be relied upon in connection with any offer or sale of securities.  The contents of this message should not be relied upon in making investment decisions.  The information and statistical data contained herein have been obtained from sources that we believe to be reliable but in no way are warranted by us as to accuracy or completeness.  The accompanying performance statistics are based upon historical performance and are not indicative of future performance.  The types of investments discussed do not represent all the securities purchased, sold, or recommended for clients.  You should not assume that investments in the securities or strategies identified and discussed were or will be profitable.  While many of the thoughts expressed in this message are stated in a factual manner, the discussion reflects only Akanthos’ beliefs about the financial markets in which it invests portfolio assets.  The descriptions herein are in summary form, are incomplete and do not include all the information necessary to evaluate an investment in any investment or strategy.

Trump’s “Delta” / Jobs & OPEC Friday / The Oil & Gas Opportunity / The GSE “Piggy Bank” and the Government “Mob” / Hamster Tracks

Trump’s “Delta”

Here we go again.  On 12/2/19, Trump indicated that a trade deal might have to wait until “after the elections,” sending the markets swooning a ghastly 2% (gasp) from an all-time high on 11/27/19 before recovering the entire move by the end of the week after “new” signs of progress yet again.  That the market isn’t completely inured to these about-faces by now is beyond me.

In options lingo, we have a term called “delta,” which denotes an option’s sensitivity to the underlying stock price (mathematically, the delta is equivalent to the first derivative of the option price function with respect to stock price).  A call option with a delta of 1 indicates that the option will move 1-for-1 with the underlying stock and is thus very sensitive to stock prices; a call option with a low delta, say 0.3, will only move $0.30 for every $1 of stock move and is considered relatively insensitive to stocks.

If President Trump were an option, he’d have a delta of 1.  Enough said.

Jobs & OPEC Friday

Friday, 12/5/19, was quite eventful.  Despite our high-delta President’s penchant for calming the market after any kind of swoon, the U.S. economy at least appears to have real underlying strength and does not need require the jawboning.

In Friday’s unemployment report for November, the U.S. economy crushed expectations, adding 266k jobs in November versus expectations of 180k.  Although the resolution of GM’s strike accounted for 46k of these “adds,” recall the 128k surprise last month vs. 85k expectations during the strike.  Indeed, in this Friday’s report, there were also upward revisions of 41k for the previous two months.  It actually seems like the U.S. economy is reaccelerating, despite the lack of a trade deal.  I have contended for months that folks shouldn’t put too much credence in the unprecedented length of the expansion but should instead focus on the relative lack of intensity of expansion over the last decade; for this reason, I continue to believe that the U.S. economy can continue to surprise people in its virility – especially if we get a trade deal.

Next, OPEC+ concluded its 2-day summit and managed to surprise the world with an unexpected additional cut of 500k barrels/day from its 1.2 mm barrels/day cut level established back in 2018.  This is a big deal.  The oil markets have been remarkably complacent even after the attacks at Abqaiq earlier this year, mainly because of the elevated inventories in the system, much of which has been contributed by runaway U.S. shale production (more on this later).  This being Abdulaziz bin Salman’s first OPEC meeting as Saudi Oil Minister, the world did not know what to expect.  Abdulaziz has now shown his cards, in my opinion, by throwing full support to his brother Crown Price Mohammed bin Salman (MbS) in a bid to remove the oil glut and “juice” the recently IPO’d Saudi Aramco.

Although crude only rallied a little over 1% on the “surprise cut,” it had already bounced 4.5% from the 12/2 “no trade deal until after elections” global market swoon.  Nevertheless, I think oil is poised to grind higher over the next year.  The forward curve of oil (similar concept to yield curve) is now massively inverted (we call this “backwardation” in the commodity markets).  This chart shows how the level of backwardation has been steadily increasing over the last several months, showing an increasing wariness of supply tightness:

Oil Backwardation

This brings me to my growing conviction in opportunity in oil & gas that I began to write about in the last several Musings:

The Oil & Gas Opportunity

This is an amazing chart:

The white line shows a chart of WTI crude, the green shows Henry Hub Natural Gas, and the purple shows the XOP (Oil & Gas Equity ETF) over the last 5 years, normalized to the same starting point to show how each asset class has performed relative to one another.  The devastating underperformance of the oil & gas equities relative to the commodities is stark.

Here are my takeaways:

  • While the U.S. has benefited from the “energy independence” from the Middle East that the shale revolution has brought, it has largely been an era of “profitless prosperity” for the U.S. oil & gas industry.
  • Despite the industry’s promises of being able to prosper above $50/bbl (you can’t see it in this chart due to the normalization, but WTI crude has been consistently above $50 since the beginning of 2017, except for a brief stint in December of 2018), the lack of free cash flow to date has all but destroyed investors’ confidence that shale producers can ever inflect to free cash flow
  • The massive underperformance of the underlying equities (purple) to the commodities (white and green) indicate a growing disenchantment with the sector – arguably reaching crescendo extremes at this point, with the entire U.S. oil & gas space accounting for less than 4% of the S&P and worth hundreds of billions less than Saudi Aramco’s $1.7 trllion alone! 
  • Note that this massive underperformance of the XOP actually understates the underperformance of the sector since this ETF only contains the largest, best-capitalized names in the space.  I follow a basket of “post-reorganized” small-caps in this space (companies that have already been through the Chapter 11 wringer once), and of the 22 or so names that I began following a couple years ago, the median ytd performance for 2019 is -54%, excluding the 5-6 names that have been complete wipeouts a second time around, going to the “Chapter 22” (2nd consecutive bankruptcy) route. 
  • I believe that investor disenchantment is warranted from the standpoint of companies showing terrible capital re-allocation skills.  This is the crux of the problem, in my opinion, for a public E&P company – what do you do with the cash flows from producing wells that are supposedly highly profitable from a well-specific perspective?  For public companies with stories to tell and empires to build, managements have typically diverted this cash flow into new projects and new acreage in sometimes unproven regions with questionable geology and economics.  So even if individual wells show 50% IRR’s, what good is it if the company continues to burn cash in aggregate?  This is why so many public E&P companies are trading below the present value of their reserves (“PV10” in industry parlance) – public markets are ascribing continued value destruction.
  • This brings to mind an interesting “arbitrage” opportunity that ideally requires activist, private equity – buy up some of these sub-scale operators trading at significant discounts to proved/developed/producing (“PDP”) reserve value, sell off the proved/undeveloped (“PUD”) reserves, and run the companies off like liquidating trusts.  In my mind, this is the only way to ensure convergence to reserve value and eliminate poor capital re-allocation as a risk. 
  • The public market alternative is to invest in low-cost operators who have a combination of good capital discipline, strong balance sheets, good inventory depth, and shareholder-friendly initiatives.
  • What is different now than years past is that company managements are finally “finding religion” and finally listening to shareholders in terms showing capital discipline; in many cases, lack of liquidity is forcing this discipline upon producers. 
    • One aspect of capital discipline is restraining growth.  Rig counts have fallen to multi-year lows as a result (although the counter argument is that increased drilling efficiency have countered much of this effect):

  • The other aspect of capital discipline is returning excess cash flow to shareholders either through buybacks or dividends. Naturally, only larger players with scale can afford to do this, and this is where I’m investing in the public space.

To summarize, the confluence of several factors is making me very excited about this space:

  • The Darwinian culling of the U.S. shale industry has forced consolidation and capital discipline amongst smaller players.
  • Big players are beginning to inflect towards free cash flow and the return of cash flow to shareholders.
  • The supply side of the equation is getting tighter:

Non-OPEC production growth (of which the largest component is U.S. shale) is starting to roll over.

iOPEC+ (the “+” denotes Russia) has shown remarkable discipline and not only rolled over its previous 1.2 mm barrel/day cuts but surprised the market with an additional 500k barrels/day in cuts.

  • The demand side of the equation has shown remarkably steady growth (see my notes from Kaoboy Musings 15) and may even accelerate with a lessening of trade tensions.
  • From a valuation and sentiment standpoint, we are at a nadir.  That said, this sector has been a “widow-maker” for many, and I caution would-be investors to do their homework and have a longer-term horizon (3-5 years) in order to weather the inevitable bumps.  For those not looking to have idiosyncratic stock risks, ETF’s like the XOP and OIH can be good sector substitutes. 

Full disclosure: I am heavily invested in this space and currently own FANG, VNOM and ET, although I frequently do relative-value swaps with other names in the sector.  My largest position, however, is in a private equity called Birch Permian.

The GSE "Piggy Bank" and the Government “Mob”

Outside of the oil & gas opportunity, my other favorite opportunity, as many of you know, are the GSE preferreds, which I continue to believe have 150%-200% upside from current levels over the next 12-18 months.  I have written extensively on this topic and would be happy to share my past Musings with anyone interested.

In Kaoboy Musings 13.5, I gave some soundbites from Judge Sweeney’s hearing in the Court of Federal Claims, where multiple classes of plaintiffs have sued the government and FHFA for a “Constitutional takings” of private property when it put the GSE’s into conservatorship in 2008 (some are suing over this event) and then again when the Treasury/FHFA enacted the Net Worth Sweep in 2012 (some are suing over this event). 

I’ve now had time to go through almost 300 pages of transcripts from that day in court and want to include some choice words the Judge had for the government:

  • “how does the Government justify never allowing Freddie and Fannie to pay off money it received and eventually being able to stand on its own feet, which it could have done, and then let its board decide whether or not to pay a dividend to the shareholders. It seems from the beginning when you have FHFA coming -- and Treasury coming to the board of directors of the enterprises and saying you either agree to the conservatorship or you’re out, it seems as though there was a death grip placed on the enterprises by Treasury and FHFA”
  • “they were never allowed to repay -- the enterprises were never able to repay that which they borrowed. And so they were never allowed to stand on their own two feet again as much as an entity can stand on two feet.”
  • “There was this siphoning of every dollar of profit.”
  • “I’m very concerned that Treasury approaches the board of directors of the enterprises and says, you either agree to the conservatorship or you’re out. That’s -- that sounds like undue influence, if not a death grip.
  • “It’s as though it was somebody --they were used as like a piggy bank that they could – or it was this funding stream. And I’m a taxpayer so, I mean, it’s great that the Government can generate tax revenues, that’s fine. But it should be fair and equitable”
  • “a reasonable plaintiff or investor, knowing that an infusion of capital was required and the Government was going to provide that infusion of capital and that the company -- in this case the enterprises -- would have the opportunity to repay the loan and then regain its footing and then eventually to be able to pay dividend, that’s what one would expect. One would not expect in the United States of America that the Government would step in with an infusion of capital and not then not allow -- and the dividends were going to flow to the taxpayers to repay the taxpayers, one would not expect that all profits would be directly flowing into the U.S. Treasury and that the company would never be able to repay that which it borrowed, get back on its feet, and resume normal operations and pay dividends again.”

At one point the DOJ lawyer characterized preferred investors as holders of “lottery tickets” hoping for a windfall, to which Sweeney replied:

  • “I appreciate your lottery ticket analogy, but the Plaintiffs owned stock, which is far more certain than a lottery ticket. A lottery ticket, you may have one in a billion or 100 billion chance of winning. Stock is something that -- it’s a certificate of ownership, you’re invested in that company and, God willing, you get a return. For preferred stock, they certainly were enjoying a return year after year after year. I think there was always a dividend paid except for maybe one of the enterprises in 1985, something like that. So, there was a fairly consistent return which is much better than lottery ticket, at least any of the lotteries that I know of.”

And finally, perhaps with Martin Scorcese’s The Irishman fresh on her mind, Sweeney says on pages 275-277:

  • “I hate to say it, I’m not -- this is going to sound so flip, and I don’t mean for it to, but this is like the mob. And it’s not, of course, but, I mean, you have all the money is being turned over to the Treasury.”
  • “But, you know, what kind of – how are they saving -- it’s almost as though the companies or the enterprises have become shells, and they’re able -- and they’re supposed to continue on in their work, but they will never make a profit because everything’s being diverted to Treasury.”

Hamster Tracks

Lastly, I want to pay homage to a long-time market pundit whom I’ve affectionately named “The Bearded Hamster.”  The Hamster was a frequent market prognosticator on CNBC; after several decades of doing this, he finally decided to call it quits last week. 

Predicting the future is damn hard to do with any sort of consistency, but what I found remarkable about the Hamster’s calls, however, was how consistently wrong he was – there is signal value in any kind of consistency, even if points you 180 degrees in the opposite direction!  In fact, long before I started writing Kaoboy Musings, I thought I would one day create a blog with a dedicated section called “Hamster Tracks” to spot what the Hamster was doing and then make the opposite recommendation. 

Tongue-in-cheekiness aside, I suspect that his consistency in making terrible calls stemmed from two primary mistakes.  First, his worldview was largely informed by “trend-following,” which generally places you among the consensus.  Now I’m not saying the consensus is always wrong.  In the financial markets, powerful long-term trends do occur and can make patient investors a lot of money.  The problem, however, is that in the short-term, being in the consensus can often mean that you’re the “Johnny-come-lately” left holding the bag when short-term winds change direction.  This leads me to the Hamster’s second big mistake: being too short-term on his calls and getting scared out of his thesis at precisely the wrong time, exposing himself to severe whipsaws, both financial and emotional.  One of the biggest impediments to investment success is one’s own emotions, and not doing proper due diligence and/or not giving a thesis enough time to play out will make it easy for Mr. Market to shake you out at the worst imaginable time.  Alas, the Hamster allowed this to happen all too frequently.

I try very hard not to be Hamster-like by 1) trying to gauge the “consensus view” embedded in the market and then deciding whether or not to join that consensus; more often than not, I tend to take the other side, because contrarian bets usually have better reward-to-risk ratios, just like betting on the underdog usually gets better odds; 2) trying to be patient and not let the short-term schizophrenia of the markets scare me out of a solid thesis; truth be told, I’ve often been “too patient” and overstayed my welcome in certain situations, so this is always a work-in-process for me. 

So I am genuinely bummed that the Hamster has called it quits, because I am losing a valuable signal going forward.  He did, however, offer one last nugget of wisdom last week: he advocated getting out of the market and going mostly into cash ◊ I guess this bull market may yet have some legs! 😊

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About

Kaoboy Musings is a private distribution list/blog that I created to encourage dialogue regarding the economy & markets, geopolitics, investment ideas, and life in general. I have a passion for the markets and investing, and even though I no longer accept investor capital, I try to keep current on global events and opportunities and remain active in the markets.  I’ve always found that writing my ideas down, sharing them with smart people, and encouraging two-way discourse and devil’s advocacy is often the best way to validate or invalidate a thesis and stay mentally flexible.

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