Value Investor Conference London

January 2016

Welcome to the 24th edition of Value Investor Digest

In this edition we feature two memos from LVIC speaker Howard Marks, both released in the past week. There is also a Bloomberg video interview where Howard briefly discusses the first memo. In addition, we feature an FT article on Amazon, an interview with Sanjay Bakshi, a recent letter from Jonathan Ruffer; there’s also a Jim Chanos video and presentation on both his short position in leveraged oil majors and his thesis on exploration and production companies; plus a video interview with David Herro on why he thinks that fears that a slowdown in China is going to disrupt the world economy are overblown.

Howard Marks Memo 1: On the Couch
Howard will speak at the London Value Investor Conference on 26th May 2016 in an audience Q&A session hosted by Richard Oldfield. Unusually, Howard has written two memos in the space of 5 days. This first memo was released on January 14th and is Howard’s attempt to “send the markets to the psychiatrist’s couch” to see what could be learned. Past memo’s have covered the idea of the swing of the pendulum between greed and fear, through the various stages of investor sentiment that lay between the two extremes. “In the real world, things generally fluctuate between ‘pretty good’ and ‘not so hot.’ But in the world of investing, perception often swings from ‘flawless’ to ‘hopeless.’ The pendulum careens from one extreme to the other, spending almost no time at ‘the happy medium’ and rather little in the range of reasonableness. First there’s denial, and then there’s capitulation.” This and the subsequent memo below are both worth reading in full, however there is a short Bloomberg video where Howard briefly discusses a small part of this memo.

Howard Marks Memo 2: What Does the Market Know?
The second memo is a follow up to the first and written shortly afterwards on 19th January. It elaborates on the theme of the psychology of market participants: “So, what does the market know? First it’s important to understand for this purpose that there really isn’t such a thing as ‘the market.’ There’s just a bunch of people who participate in a market. The market isn’t more than the sum of the participants, and it doesn’t ‘know’ any more than their collective knowledge. This is a very important point. If you believe the market has some special insight that exceeds the collective insight of its participants, then you and I have a fundamental disagreement. The thinking of the crowd isn’t synergistic. In my view, the investment IQ of the market isn’t any higher than the average IQ of the participants. And everyone who transacts gets a volume-weighted vote in setting an asset’s price at a given point in time.”

Amazon: How to be a Bull
For most Value Investors Amazon is not easy to value. Amazon yields little cash, about $1.30 per share and it is currently trading at over $550. Therefore, all sensible valuations of Amazon will value it on the basis of what it might become, as far away as 2035 according to this article in the FT and perhaps using Wal-Mart’s growth trajectory as a proxy. Whilst growth that materializes will always be a part of value – being sure about the level of growth that will be achieved and how it will translate to earnings is altogether a more difficult prospect. There are some Value Investors that have identified value in the growth path they expect for Amazon – for instance, London based value investors Mundane Asset Management have held a substantial position in Amazon: recently, more than 20% of their World Leaders Fund was in Amazon stock (as of October 2015).

Interview with Sanjay Bakshi
There are 2 parts to this interview, Part 2 can be accessed from a link at the bottom of the article. A variety of topics are covered including his views on buy/sell discipline, investing in airlines and also brand value: “There is a lot of fuzzy thinking about sources of competitive advantages. While it’s great that authors like Pat Dorsey and others have written about these sources, one has to keep in mind that these things don’t live in silos. They overlap. Take brands. Don’t they create high switching costs? Of course they do. Switching costs are not just financial; they are also psychological, and successful brands make customers switch them from system 2 type of reflective thinking to system 1 type of automatic, reflexive thinking. Why do most customers automatically pick Heinz ketchup instead of the cheaper, store brand ketchup from the supermarket shelf? Brands also create scale, and scale produces cost advantages…”

Ruffer Investment Letter
This letter was written 3 months ago by Jonathan Ruffer, it is full of insight in to where he perceives risk to be at present: “I am intrigued by the nature of risk at the moment. Wearing my hat as a trustee of a family trust, I found myself reviewing a portfolio which, by today’s standards, had an exceptionally high yield – upwards of 3%. I asked the managers if they were comfortable with this, and whether they would opt for a lower yield if they were free to do so. The response was that it would give the managers the latitude to increase the risk by investing in low–yield stocks. The thrust of my question, of course, was that the high–yield portfolio was high–risk, since it concentrated into those stocks which all yield–seekers had sought out, and would be the most vulnerable if financial conditions reverted to something more normal…when you overpay for a ‘safe’ asset, it becomes doubly dangerous, since you have no possibility of being bailed out by happy surprises; it was bought for its inability to surprise in either direction.”

Jim Chanos Short all of the Leveraged Major Oil Companies
This Jim Chanos video with CNBC (skip to 3 minutes 15 seconds in) details that “you can be pretty much sure that we are short all of the major leveraged oil companies”. Related to this video but providing more detail specifically about the exploration & production space of the industry is this powerpoint presentation given in October 2015 by Chanos. The presentation analyses the economics of E&P in recent years – according to Chanos the extent of capital market support for energy since 2010 is demonstrated in energy companies’ financial figures; cash flow from operations at many major E&P companies has not covered capital expenditure since 2010. “We don’t think the model worked at much higher prices because the wells just deplete too fast, so you constantly have to reinvest to keep your production constant – that’s a whole different story than the integrators.” 

Fears that a Slowdown in China is Going to Disrupt the World are Overblown
David Herro, CIO of International Equity at Harris Associates says in this video interview with Bloomberg that “it doesn’t really matter too much to the global economy if [Chinese growth] goes from 7% growth to 5% or 6% growth”. He speaks about how average GDP per capita on a purchasing power parity basis in China has risen from $1,000 at the turn of the millennium to $10,000 today. At growth rates of even 10% back in 2000 the higher growth rate didn’t have so much of an impact on the world economy. Today, given the higher absolute level of GDP per capita in China “a growth rate of even 5% has a large positive impact on the world economy.”

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