Greenstone Value Opportunity Fund, LP 2010 Annual Letter (Distressed, Deep Value Fund)
After closing three strong years of performance (2008 - 2.5%, 2009 - 36.5%, 2010 - 15.6%), Greenstone shares its outlook for 2011, as the year of "dividend chasing." 2010 was certainly a year of "credit chasing," where all funds searched for yield in high yield bonds, leveraged loans, and REITs. About 80% of the Greenstone portfolio is investing in traditional deep value securities, and 20% is invested in "special situations." The last bullet point in Greenstone's themes is that historically, "economies with the highest growth produce the lowest stock returns by an immense margin (yes, you read that right). In fact, stocks in countries with the highest economic growth have earned an annual average return of 6%; those in the slowest-growing nations have gained an average of 12% annually (source: Credit Suisse Global Returns Yearbook). This could be especially true in 2011, where equity investors in emerging markets are fighting policymakers."
Here are Greenstone's selected themes for 2011:
• We still like equities, particularly in the U.S. While they currently seem short-term overbought, and a technical correction is possible, we still see the most value in this area, especially when we consider the alternatives.
• In reviewing our letters from early last year, we talked about 2010 being the “Year of the Yield Chaser” in the credit space. We cut the majority of our credit exposure in Q1 and Q2 of 2010 because of what we thought was limited further upside appreciation potential. We can see 2011 being the “Year of the Dividend Chaser”.
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• Offshore deepwater drilling is the last bastion for hydrocarbon discovery. We think a lot of “first time” emerging market demand characteristics and higher oil prices will lead to increased deepwater programs by the IOCs and NOCs. We have a handful of positions that give us exposure to this area.
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• We would consider shorting natural gas companies because of the supply/demand dynamics and high valuations. We could see a scenario where the contrarian call is to go long physical natural gas because 1) it’s unloved and 2) the historical ratio between gas and oil prices is creating the perception that gas might be a buy. However, even with increasing demand for natural gas expected in the U.S. this year, we still have a tremendous overabundance of supply. We’re keeping an eye on high multiple natural gas companies and MLP’s that derive a generous amount of “other income” from hedging programs that are set to roll off.
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• The M&A space is one that, for various reasons, we see doing well going forward. This primarily derives from the cash reserves on S&P 500 company balance sheets, which are at the highest level in ten years (currently over $1.2 trillion). This is almost 50% more than the $825 billion held in cash in September 2008. Information technology is the leading sector with cash reserves. With a near 0% interest rate environment, how long can companies hold so much cash? VC’s and Private Equity have not had a genuine chance to monetize their portfolios for 2-3 years now, and we believe they will search out the cash rich/public company exit option. We currently have 5+ names in the portfolio that we believe could benefit from such a trend.
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• This year could finally be the year where companies have the ability to pass through their increased input costs to consumers. This would result in inflation showing up in the U.S., despite what the CPI is saying.
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• Along with middle of the road valuations, allocation shifts could be a boom for the equity market in 2011. It is interesting to hear people like Byron Wein say that “Institutional portfolios have to have more of their money invested in places like China, India, and Latin America,” essentially saying that developing countries are generating a majority of the world’s growth, and institutional portfolios should have exposure to these markets. Mr. Wein recommends large conventional institutions substantially increase their allocations to hedge funds and emerging markets.
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• European and municipal debt issues will once again provide buying opportunities when the markets turns south on these worries. With municipal budgets due in early June, expect more movement in and around this time frame. We have taken advantage of market gyrations that these events have previously offered, and would look to do so again.
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• The dramatic equity rally from the lows at the end of June occurred almost entirely with net outflows from domestic equity funds, and net inflows into domestic fixed income funds. Late in the fourth quarter, this dynamic switched for the first time in a long while, with inflows into equities and outflows from bond funds. If this trend continues, which it appears that it might, even more fuel could be added to the recent stock market rally.
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• Even in light of the money flows just mentioned, we don’t expect John Q. Public will come charging back into the market any time soon. We are wary, however, about the potential shift of pensions and endowments (who manage John Q. Public’s money) into equity markets. Essentially, there are way too many underperforming endowments (relative to their liabilities), and they may be forced to chase returns in order to meet their obligations.
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• In contrast to the Byron Wein bullet point above, Elroy Dimson of the London Business School has decades of compelling data from 50+ countries to support the view that high economic growth in emerging markets doesn’t ensure high stock returns. His book, ‘Triumph of the Optimists: 101 Years of Global Investment Returns’, along with several other studies, have underlying evidence that economies with the highest growth produce the lowest stock returns by an immense margin (yes, you read that right). In fact, stocks in countries with the highest economic growth have earned an annual average return of 6%; those in the slowest-growing nations have gained an average of 12% annually (source: Credit Suisse Global Returns Yearbook). This could be especially true in 2011, where equity investors in emerging markets are fighting policymakers (who are trying to cool off overheated economies with monetary policy, etc), while developed markets are receiving tailwinds from policymakers (who are aggressively trying to lift the prices for risk assets). While many are clamoring for additional exposure to emerging markets, we believe the best risk/reward is to continue to find value in developed markets like the United States.
http://leverageacademy.com/blog/2011/02/25/greenst...
Letter from Distressed Debt Investing Blog
Some interesting points, but
Some interesting points, but I have to immediately discount anyone who argues that 2011 is finally the year for corporations to pass rising input costs through to the U.S. consumer.
Anyone who thinks about that for 10 seconds should realize what non-sense that is. If 10% of the country is unemployed, another 10%+ is underemployed and 25% of homeowners have negative equity, where will the demand come from? Yes, producers of basic staples such as bread and cereal may be able to push through small increases (or at least reduce serving sizes), but, in general, the Consumer is tapped out. This is especially true if volatility in the Middle East doesn't go away soon (which it won't).
Corporate margins are about to get crushed...until more people start getting laid off...
It's nonsense to paint the
It's nonsense to paint the difficulty of passing price increases to consumers with a broad brush.
You need to look at capacity utilization in the industry and there are some that can and will pass on prices, like high-end jewelers or the oligopolistic industrial gas distributors.
I also think its nonsense when people speak of unpredictable situations-like the chaos in the middle east- with unwavering confidence.
Sorry man, that just doesn't
Sorry man, that just doesn't hold water. And the broad brush comment sounds like someone trying to impress their professor. Leave it in the classroom.
The current economy is zero sum game for U.S. consumer spending. Yes, some (wealthier) people will probably be willing to pay higher prices for high-end jewelry and the vast majority of consumers will pay higher prices for gas/electricity/heat, etc., but that just leaves less to spend on other goods and services. What does an increase in pump prices do to U.S. consumer spending (and as a result GDP)??
As for the Middle East, when the U.S. and Germany decide to send naval units on unscheduled campaigns to the Persian Gulf and there's serious discussion on military intervention in Libya, I think it's safe to say that things aren't going to be alleviated anytime soon.