Deep Value –

Watched a Google Talk on Deep Value by Tobias Carlisle on YouTube: http://youtu.be/1r1vJZ80Z7I

Take-aways:

• Models perform better consistently than human judgement
• Graham Net-nets still work

Decision: 

• Apply Graham’s net current assets method to a basket of Chinese companies over a period of two years.

Greek banks

Couldn’t resist the temptation, bought into two Greek banks, alpha and national, on low p/tbv at 1% of the portfolio each.

Australia thoughts

Australian elections won’t be until 2017. The way Abbott/Cormann deals with the Australian economy will determine how extended the bubble becomes.

Lesson in patience & Due Diligence

Losses taken on Want Want 151 hk.

The call position was bought for exposure to Chinese consumers, but no fundamental research was done on the company and I failed to identify the key drivers to its underperformance, namely disappointing earnings in its milk and snacks businesses.

Thankfully the position was sized to be under 1% of the portfolio.

But even so, I should have researched the position first and not allow it to run and lead to a loss on the entire position.

Other positions to be reviewed and monitored similarly.
Stop losses to be set up.

Financial history

Food for thought: why is it that 1965 seems like an ancient time – to the point of irrelevance – in the collective memory of the financial industry while it is seen as relatively recent for political history – and still constitutes a fruitful source of study?

Does this reflect the short-termism of the financial industry or is the short-termism a consequence of the pace of change in the financial industry?

Questions on China

Questions I will seek a view on for China:

China’s property sector:
– how scary is overcapacity?
– how leveraged are the companies?
– how expensive are the homes being built?

China’s banking sector:
– why are they valued at low price to books?
– how exposed are they to bad debt, wealth management products, local government projects?
– understand different types of shadow financing: entrusted loans, wealth management products, commodity-backed lending, LGFVs

China’s consumers:
– how will the New Economy look?
– how strong are Chinese households and what will they buy?
– which companies will be the beneficiaries of the change in the Chinese economy?

China’s economy: the current administration seems less intent on reported top line growth and is trying to tackle fundamental problems in the economy. What form will further “easing” take in China and how will they affect i) the Chinese economy, and ii) Chinese companies?

General questions:
– how likely is it for China A-shares to decline by another 10-20%?

Action: research needed on Chinese real estate, banks, consumers and economy

Preparing for European QE

Lots of speculation that Draghi will announce QE this week, eurusd is down at 1.15 and the Swiss National Bank last week decided that it won’t defend the euro peg.

European QE should be a net positive for European households and corporates. As such, consider loading up on related stocks once QE announcement is made.

Trade idea: park cash in the Hong Kong index on sell-off of the FXI.
Then selectively buy European exporters.

ETF Playbook for a higher Vol environment with no QE and an impending rate rise

With QE gone and less certainty about rates, the only trade now is to go long vol in a big way. We will need to get used to having s&p vol at 20% (ivm even higher!) and daily index moves of +- 2%.

Poor US retail sales were to blame for the slide in the US market today, indicating that the market (makers) do not have a strong sense of direction.

Now is the environment to be buying quality companies when they fall and buying put options or shorting bad companies when the market rallies.

My playbook on ETFs/options will be:
1. Short/put CEMB US (em bonds) on i)dollar strength, ii) widening credit spreads/higher risk premia by June 2015
2. Short/put JNK US (US high yield bonds) on i) oil, ii) widening credit spreads
3. Short/put SPY US (S&P500) on i) multiple contraction

This playbook requires fairly nimble operation to take advantage of index etf volatility.

The S&P is unlikely to rise by kite than 10% this year but intrayear there may easily be 10%+ declines. Will need to stay positioned for these.

Santander

From Bloomberg:

SANTANDER STREET WRAP: Share Sale Removes Negative on Stock

By Chris Malpass and Blanche Gatt
(Bloomberg) — Santander raised EU7.5b in a share sale yday and announced it’s cutting the dividend. It also posted a 30% increase in 2014 net profit to EU5.8b. Analysts say move is positive even as some uncertainties remain.

Shares fall as much as 10.7% in early trading, most since May 2010; were suspended yday

BARCLAYS (underweight)
Move will accelerate capital build, bring it closer to peers
Also cut in scrip dividend will reduce dilution of recent years
Reassuring that no big M&A planned in S/T or M/T

RBC CAPITAL (sector perform)
In terms of valuation, capital increase and dividend cut will cancel each other out
Extra capital puts it in line with peers
Read across limited as Santander has said capital will be used for organic growth
Similar moves by peers would be more negative as they can’t offset it by reducing scrip
Earnings ests. cut 7% to 9% on LatAm weakness

BERENBERG (sell)
Capital is still inadequate, shortfall may be EU5b. Pro forma Basel 3 fully-loaded CET1 of 10% still short of peers’ 11%. Major concerns remain as strategy focus is on growth and macro risks remain in Spain and Brazil. Confused about statement of no short-term M&A as Santander said it’s looking at Novo Banco

Read across is negative as pressure rises on peers to raise capital; sees capital deficit of EU5b at Deutsche Bank, EU10b at BNP Paribas, EU10b at Credit Agricole, EU10b at SocGen, EU1b at Commerzbank and CHF10b at Credit Suisse

CITIGROUP (neutral)
Santander guidance for CET1 ratio jump to 11% in 2016 from 10% in 2015 implies use of deferred tax assets in Brazil and Spain
Cuts 2014-2017 EPS ests by 5%, 9%, 8% and 7% respectively
Sees general earnings decline in Spain, Portugal, Brazil, Mexico and rest of LatAM
Sees earnings increase in U.S. and U.K.
MORGAN STANLEY (equalweight)
Pre-announced 2014 net EU5.8b implies 4Q net EU1.45b
That’s 7% below MS est, in line with consensus
Guidance for 10%-11% CET1 ratio in 2016 implies slower capital build
Capital increase yday should still put capital concerns to rest
Sees risk to earnings from Brazil where MS forecasts 10% avg annual earnings growth for 2014-2017
Sess U.K., Spain market share increasing

BOFAML (neutral):
Welcomes capital reinforcement, new div. policy
Says mkt saw bank as inadequately capitalised; capital increase puts bank in line with sector avg.
Bookbuild implies ~9% share count increase, ~6%-7% EPS dilution in 2015-16; adds ~3% to NAV/shr
Bank’s statement on FY net atttibutable profit of EU5.8b is 3% above BofAML est., in line with Bloomberg consensus est.

SOCIETE GENERALE (hold)
Share sale, new dividend policy remove main negatives on stock
Uncertainty remains over potential outflow from high dividend indexes
Some of that impact softened by keeping January and April scrip dividends
Main downside risks come from EM, exit from high-dividend indexes

GOLDMAN SACHS (neutral)
Capital increase is positive move
Decision for fast one-time capital increase better than slow capital build
Capital increase brings Santander in line with peers
Dilution from capital increase is likely to be offset by reducing scrip component of dividend

MEDIOBANCA (Neutral):
Capital increase is S/T pain to restore sustainability
Underperformance in S/T is price to pay to correct distortions from EU0.60 scrip DPS commitment, gain future flexibility
Share sale is strategic U-turn by new management; adddresses standalone issue, is not aimed at satisfying M&A ambitions
Still sees in-market M&A as “on the cards”; says Bankia is “very good fit”
A Santander-Bankia merger could bring EU0.6b cost cuts, EU145m funding cost savings, EU3b writeback from Bankia’s written off DTA
A combination could add 7%-26% upside to PT

Review: on the whole, strong message from the new boss positive to show who’s in charge. Start building a position. Even after dilution, dividend is 5%+

Risks:
Euro weakening with potential QE — sell euros and add to position when QE announced.
Further weakening in Brazilian consumers.

Opportunity: leading position in Spain, UK, Brazil.

Thoughts on S&P put options

Spent some time thinking about how I use put options on the s&p etf and also how I ought to size the position and when to trade this.

I use put options on SPY US for two reasons:
I) portfolio hedging
Ii) speculation

For hedging purposes, I already have an adequate number of contracts to cover my portfolio and my trading strategy for this should be to hold until expiration. That I do not touch this portion of the portfolio is sacrosanct given its status as a hedge and I must not be tempted to sell even when option values rise.

What tempts me to speculate using s&p put options is the desire to express the view that the S&P 500 index will decline once the US Fed starts to raise rates (March? April? January?). The veracity of this basic thesis can be seen in the amplitude of the declines in the index ever since the end of Fed tapering.

However, I should not use this as a reason to trade the puts I already hold for hedging purposes. Instead, I should purchase a separate set of long dated options at low ivms and sell at my discretion.

Even better, though, I should think through the view and create a set of positions that have a better payoff distribution, including the possibility of buying puts on the junk bond index, for example.

Decision: DO NOT sell my existing put options on the s&p but consider putting on a set of trades to express bearish views on equities and junk bonds.