QB
ASSET MANAGEMENT
www.qbamco.com
1
See Important Disclosures at the end of this report.
July 2013
Value is the Thing
Take a big risk to grow and add jobsManufacture disks to rid corn of their cobsKernels for bisques and gluttonous hogsThe idea can’t miss, wealth by the gobsBut o’er in a land far, far awayA small little brand and a sweaty arrayOf cheap, hungry hands foregoing all playProducing cob corers for two bucks a daySales soon drop as waist belts get bigCanned bisque is a flop, up is the jigNow only needed as slop for the pigsProduction to stop? (Unlikely, you dig?)The factory is “fair” cause workers stay satedWith bennies and shares and grandeur now datedBosses need only keep shareholders elatedBy showing great flair at new highs unabatedCobber Inc. shares rise year after yearThrough buybacks contrived to make them more dearDebt long-lived to some distant yearFunds the whole lie that production is hereAnd so it goes…The economy grows, see NGDPThough everyone knows the growth isn’t free
Real growth
may be slow but don’t disagreeContinue the pose (even when negative, see?)Growth’s only good when capital’s builtDebt’s dead wood when it’s done to the hiltLook under the hood and under the kiltReal value has stood when growth starts to tiltOnly three ways to mend leverage amokFormally suspend all debt owed in bucksOr let debt end on its own (that sucks)Or simply rend new money in trucksSimple and significant in drink and clear thoughtForget what they think and what you were taughtPrice metrics stink when they’re commonly sought
Real value’s the thing
, half sold is well-bought
QB
ASSET MANAGEMENT
www.qbamco.com
2
See Important Disclosures at the end of this report.
Beta Blockers
Those who believe in the random walk theory suspect there is no point in trying to outthink the market.Efficient market theorists raised this notion to new heights, using elaborate calculations to show thateven though one in a thousand monkeys would be able to pick the next ten-bagger, there would be nocausality. Both see markets as fairly efficient pricing mechanisms because market participants havemore or less the same amount of relevant information on which they may invest rationally.In our view, public markets are incredibly
inefficient
when it comes to accurately pricing
risk-adjusted
value because they are, by their very nature, organisms that reward or punish assets based on theaggregate of investors’ lowest common investment objectives over the shortest of investment horizons.The argument that only fools try to outthink the market rationalizes index (i.e., “social”) investing. Socialinvesting makes investing seem more like saving. When most investors remain fully invested,perpetually dedicating the great majority of their capital to the markets regardless of underlyingvaluations or risks, it follows that market pricing is determined by non-cognitive speculators. So, while itmay be true that markets are always right at each point in time, they usually do not reflect sustainablerisk-adjusted real value. How else might one explain negative real interest rates or Pet.com?The weak link in the whole chain is not the inability of experienced people to recognize true value, butthe institutionalized idiocy of beta investors exercising their mandated fiduciary duties. Ultimately theirportfolios may be treated like lambs to slaughter but it will occur with most everyone else and seem likea natural disaster no one could have foreseen. In the interim, they appear to be prudent andresponsible. As the logic goes, if one is hugging an index (overtly or closeted), he or she is taking no risk.The market’s overall real valuation – rich or cheap, no matter – plays no part in decision making.Fat Tails, easily definable events we know
will
occur but not
when
they will occur, are not Black Swans,Nassim Taleb’s metaphor for unforeseeable exogenous shocks. We think the fools are those taking greatrisk in the markets by ignoring both, the ones mistaking speculation for saving. The default objective for
savers
should not be degree of market participation, but rather purchasing power maintenance. Thedefault objective for
investors
should be purchasing power enhancement (i.e., positive real returns).
The truly adult approach to capital markets should be the quest for risk-adjusted Alpha, in our view, and the most reliable strategy to find it consistently is through real value investing
.
Indeed, markets priceassets nominally for all known information today; yet they do so for tomorrow. They are unconcerned with risk-adjusted real value or the day after tomorrow, and that is the opportunity for those who think.
A Simple Investment Thesis
For stock investors, investing in a good business at a good price has always been the most reliablemeans of generating risk-adjusted excess returns over time, and yet in the current environment earningrisk-adjusted Alpha through value investing would be incomplete without fully appreciating the impactof macroeconomic inputs. Is it really different this time or have the best investors always chosenbusinesses by having a thorough understanding of their relative importance within the context of macroinputs, such as inflation expectations, policy interventions, fluctuating currencies and trade agreements?
Capital allocated to good businesses bought right is great. Capital allocated to good businesses bought right consistent with supporting macro trends is oftentimes better. Capital allocated to good businessesbought right in anticipation of reversals in macro trends can be best – in fact, phenomenal
.
QB
ASSET MANAGEMENT
www.qbamco.com
3
See Important Disclosures at the end of this report.
Our sense of sustainable value in today’s global markets is tied directly to the general perception of future inflation
.
The overwhelming majority of investment capital is positioned for low inflation today and tomorrow. This implies and explains the current dominance of levered revenue models sponsored by levered investors borrowing from levered creditors. Were expectations of rising inflation to come to the fore, we believe un-levered assets and businesses that do not rely on ever-more public leveraging would perform far, far better than currently levered assets owned by levered investors selling goods and services to businesses and consumers that fund their purchases through credit.
Since very few investors expect rising inflation anytime soon, the return skew is overwhelmingly positivein its favor. Both deep value and gamma are buried in the changing popular perception of futureinflation, and the best part about this is that rising price inflation expectations are precisely what all central banks around the world will soon be forced to promote. Don’t fight the Fed – front-run it.
Macroplasty
Macro trends impact global, regional, sector and entity-specific revenues, costs, earnings by impactingthe magnitude of supply and demand for specific goods and services. They also drive the relative valueof currencies in which assets are denominated. As we have seen so often, rotating central bank currencydevaluations signal predictable corporate strength in certain domiciles and industries over others.Macro considerations need not be abstract. Would Wal-Mart have a viable business model without low-cost foreign production? What would GE’s enterprise value be without GE Credit and an accommodativeFed? Would the business flowing through Goldman Sachs be nearly as robust were it not for the Fed’sreliably accommodative monetary policies? Would weakening JPM earnings make steepening yieldcurves more predictable? Would health care costs (and revenues) in the US have risen at the same torridclip were Americans not getting older, or if insurance premiums were not ultimately subsidized throughever-increasing government deficit spending that funds Medicare and Medicaid? Will Appleshareholders benefit more over time than the providers of credit for consumers buying its products?Macro may be the new black, and for exceedingly good reasons, but it seems very few are profitingdirectly from it today. Is that because most are dull or ill-informed, lazy or not in touch with goodinformation? We don’t think so. More likely it is because our currencies are moving targets, andtherefore the secular value of everything cannot be accurately judged. Macroeconomics cannot bereasonably explained or anticipated today, and, as a result, macro-market cross-rates and relative valuescannot be quantified. If we may, macroeconomics has been reduced by world-improving monetaryauthorities to the study of gibberish. The folly (“I’m tapering, just kidding, I’m tapering, just kidding”)would be funny if it were not so real and contemporary and meaningful.The entire spectacle is manifest in the public capital markets where almost no new capital is beingformed, or (and here’s the weird part), where little
sustainable
wealth is being created and transferred.Our time is defined by economic releases suggesting little and unreserved electronic credits hop-scotching back and forth in search of financial return. Bernanke or Draghi, Ackman or Icahn, place yourbets. (Hey, I love this guy cause I make money betting against him!) Where’s the value proposition?As humbled investors longing to be falsely modest, we need not be bitter by the markets’ de-emphasison real value or on the value of experience (or even on the evanescence of the Dollar Empire). We shallapply ourselves further and stay the course, just in case everyone acknowledges once again that the sunrises in the east and markets are for capital formation and pricing. To find real value today we take afresh look at economic fundamentals and the implied commercial fundamentals beholden to them.
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