Week Ending 3/27/2020 - Bear Rally?

3/23/2020 Monday

I already sold down most of DLR and switched to DLR's preferred's last week. Turns out to be a ninja move. That stock got crushed 11% today. 

Sold a little more DLR today. I did not want to reduce overall portfolio exposure though, so I rotated that money into SBUX and GOOGL.

Even though the market is down some 30%+ (I can't even keep track anymore), there are still very few bargains out there. Some of the names are getting close though - a 10-15% leg down and I'm ready to buy them.

3/24/2020 Tuesday

Whoa, S&P 500 up 9.38% today. This must have been a vicious rally for short sellers. 

It caught me off guard too. I'm still under-exposed for some growth names (UBER, TTD, SQ) and hoping for those prices to go lower. I was just doing some work on EW last night trying to figure out growth runaway and TAM.. I was ready to buy it on a decent drop today! But the stock went up 17.6% instead! 

So this rally is kind of a bummer.

The 1929/30's Depression era comparison continue to pile up - but on the upside this time.

At least one fancy footwork I did kind of paid off. I had switched out of DLR equities into preferred's last week, just before the stock had a meltdown. Then Fed announced they will expand QE to buy corporate bonds also (I expected this but not this soon!). This should calm the credit markets and help the preferred's too.

Overall my portfolio exposure still hover around 60% equities. The moves I did the past 2 weeks are very incremental.

3/25/2020 Wednesday

Late last night congress reached a $2 trillion deal, and the market continued to rally today.

This $2 trillion won't mitigate all the damages the economy will sustain, but it buys time and minimizes the catastrophe. So it's reasonable that markets are already looking out to the other side. 

I am also looking beyond the Covid-19 induced recession. Always have. I'm just not so bullish about it.

I'm not doing much. Added a few shares of SQ. Yes it's up like 50% from the lows.. but it's still below my original purchase price before this whole crisis. So technically I'm averaging down. This is still a small position so whatevers. 

More about those preferred's. The DLR preferred's I bought has done really well but I could have done even better. 

AT&T's 4.75% Series Preferred went up 19% today! I did not buy this one. 

My thought process - as I wrote last week - was that low coupon preferred are less likely to get called so you're not going to get those huge yield-to-calls (in some cases 30-40% YTC). But I forgot low coupon securities have higher duration. 

And that's the point of this trade - own high duration stuff in advance of credit market calming (with a big assist from the Fed buying corporate bonds). 

Being a former fixed-income guy I actually thought about that dynamic but dismissed it. Lesson learned.

3/26/2020 Friday

Market seem to calm down a bit - S&P dropped only 3.4% today after a massive run up.

The more I learn about the fiscal stimulus/relief bill (CARES Act), the more impressive it looks. 

Aside from the various small business relieves, what stood out to me the most is the ~$450bn of Exchange Stabilization Fund as buffer against losses, which can be leveraged up to $4-4.5 trillion of lending by the Federal Reserve. 

The Fed balance sheet already exceeded $5 trillion, and they're talking about doing another $4.5 trillion of lending! 

So we not only have massive fiscal stimulus, but also a massive expansion of monetary base in addition to what already occurred this month. 

The scope, size, and speed of government response is truly historic. I was there in 1Q2017 when subprime blew up and can't remember the government doing anything. This time it's all hands on deck. 

Frankly I was almost looking forward to the Great Depression, but looks like that won't happen. Have I missed an once in a life time buying opportunity? Oh wells. 

Inflation Loops

Edit 1: I bought some DLR preferred at discount last week. Preferred stocks are ultra long duration instruments sensitive to changes in yield. The immediate bet is on credit spreads normalizing, but longer term it's also a bet on inflation. So that's where the below analysis is coming from.

-------------------------------------------

Consensus is that we are going to a zero interest rate forever, Japan like deflationary scenario. But here's how inflation can happen.

The inflation that markets worry about is not an one-off event, but higher prices year after year. 

For that to persist you need some sort of positive feedback loops. Here's what I think the loops are:

1) the "price increase -> wages up -> price increase" loop. Some initial supply shock raise prices (e.g. coronavirus shuts down supply chains). Higher prices lead to labor demanding higher wages (and with government and politics shifting left, labor is more likely to get higher wages). Higher wages force firms to raise prices. 

The cycle repeats itself as long as labor can raise wages and firms can pass through price increases. That requires:

• a) labor having bargaining power over firms
• Technology and automation decrease labor's bargaining power and lowers wages. Stalling technological advances can help labor here. 
• Politics can also help labor over firms.
• b) firms can raise prices because demand is not the issue, but supply is.

2) The outer loop:  The "price->wages->prices" inflation vicious circle invites government action. Government not only goes to bat for labor, but also intervenes in some heavy handed way (price controls, industrial policies..etc).  This leads to resource misallocation and output shortfalls in the product and services that people actually want. Supply side issues lead to higher prices and the vicious circle reinforces itself. 

Week Ending 3/20/2020: Watching Losses Mount

A day by day account of a tough week.

3/16/2019 Monday

Stock down 12% today!? Funny how I’m so desensitized to 5-8% moves now.

Any random stock gets hit 15% today.

I have several down 20%+ (e.g. SQ, STOR, FNF).

Square's meltdown is entirely expected, I was just too pigheaded to sell before their upcoming investor day.

STOR - the early hits had some elements of reflexivity unwind (this is growth by acquisition after all). But the new hits are due to worries about tenants renegotiating rent deferral or even rent holidays. My view is that's ok, STOR has enough liquidity to survive and thing will be back to normal in an year or so.

FNF was completely shot and I don’t quite get it.

------------------------------

I suppose this is the beginning of a new, prolonged bear market, under which stocks can be down 90% before it recovers.

The past few years I've WANTED a recession. I figured I hold more liquidity than most and can survive and take advantage of the situation. Now that the crisis is in front of me, the mental stress is almost unbearable.

I'm actually fairly calm during the trading hours. The hard part is after market closes and I go through my portfolio and count the losses. That's when it hits home.

I agonize over my own inaction. Even though I'm technically executing my plan. I upgraded my exposure in January and Feb with the idea that should a 2008 style crisis hits I will keep my stocks and ride out the losses.

Well, that crisis is here. I'm executing my plan. I'm just not sure that is the correct strategy...

Will I end up panic sell at the bottom? To fight that instinct I got a list of stocks and the prices I want to buy them at; and I will force myself into buying when those prices hit. Even if it's tiny positions.

Things are starting to looks worse than 2008 - 1929 / Great Depression is now the comp.


3/17/2019 Tuesday

Stock went up 6% today after Mnuchin and Trump talked about helicopter money.

I added 3% to my equity exposure today. 1% each to STOR/FAF(to replace the FNF I sold earlier)/BRKS. They are cheap enough and solid enough that I'm wiling to sit long term and take short term pain.

I added a little to SQ on whim after the Mnuchin speech, but will have to offload that addition tmw - here's why.

After market closes I had time to reflect. Directionally, the helicopter money approach is correct but I came to the conclusion it just be enough. The local restaurant might pay $15k a month in rent. How is $1000 going to help them stay alive when revenue goes to $0?

Some back of envelop calculation: US has $20trn GDP. Let's say 1/3 of that shuts down. And we shut down for 2 months. You got 20/3/12*2=1.1111. That’s $1 Trillion hit to GDP. But GDP doesn’t count intermediate goods, so the real amount that needs to be bailed out is probably a multiple of that.

Ideally, the government says "let's freeze time, everyone stay home, business keep their employees, we'll pay your expense". But that’s going to be an astronomical number that makes US debt/GDP go to unreasonable amounts and USD will totally lose credibility.

All we can hope for is the shutdowns flatten out the disease curve, buy us time so healthcare system doesn’t get over whelmed. Some business will go bankrupt but hopefully you save enough of them that we don’t get a permanent damage to economy that we cant bounce back from.

There is some offset here. Big companies like Facebook are already reaching out to small businesses and employees, in the form of cash grants and product credits. So maybe everyone shares some pain but no one goes under, then we bounce back?


3/18/2020 Wednesday

Another wild day. S&P down more than 5% today. Frankly, I expected worse. Stock futures were limit down the night before so I knew it was going to be ugly.

It now looks like teh fiscal package wont' be enough, and in any case it hasn't passed yet.

The situation deteriorates every minute.

Stock went down 9-10% ..(this is truly looking like 1929), before clawing back to "only" down 5%ish.

My buy limit order for TTD hit at $153 and so I added a little there. But I'm mentally ready for this thing to be down 80% from peak. That would be below <$60.

I don't know when the market will bottom, but I don't want to reduce on the way down and not have enough exposure when it roars back (and given the speed of the decline, its very possible the market recovery will be just as violent)..

So the plan is add on the way down, however incrementally.

TTD, SQ, UBER. I have small positions in these, all are potential 10 baggers if I can accumulate in the right price. Hopefully by the time market bottoms I have a decent position in each of these (and other oligopolies in structural growth markets with strong moats). Then maybe add on the way up?

It's way early to talk about recovery, but I can dream right?


3/19/2020 Thursday

A relatively calm day in the market. Markets went up but this is a very weak looking bounce.

Some of the big shorts names like Hempton, Cohodes came out yesterday and say they're no longer net short. Ackman talked about buying BX.

Yesterday, I talked about accumulating on the way down. As if to demonstrate the rightness of that logic, Uber was up 37% when I checked. Company says 80% of cost is variable, so they will be able to cut cost, survive and come out stronger.

Natera (NTRA, which I don't have) was also up about 40% today. Any glimmer of hope does wonders for beaten down stocks.

The market heat map (below) shows rotation away from defensive/yield names. the market didn't move up too much, so apparently there's no inflow to funds but managers are positioning for a risk-on rally? If so, they risk getting wipsawed and their selling will exacerbate the downward move. This can end in tears.

It's pretty hard to ignore the market, focus and do fundamental research. But i will try to do that today.

Trades

I cut some DLR as it breached MA50. I also sold EQIX. These are expensive stock that have held up but are liable to get hit. EQIX for example has <2% div yield. That makes the valuation dependent on growth, and that means acquisition - so reflexivity unwinds as stock prices go down.


3/20/2020 Friday

Spent time looking at preferred stocks today. There's a massive dislocation in the credit market. Credit spread have blown out and a bunch of preferreds are now trading at discounts to par.

It's tempting to look at Yield to Call (in some cases showing 30-40% upside) but that is not right for preferred trading at discount:

1) companies have no reason to call securities trading at discount.

2) the logic of yield to call is somewhat circular: to get the YTC you need the prefs to get called. But a company will call only when prefs trade at premium, which happens only when market yield comes down to below the preferred coupon.

So the bottom line is to look at current yield for preferred trading at discount, and compare that to the coupon to see how likely you are to get called at par.

------------------------------------
What an exhausting week. This is supposedly the worst week in the market since 1929.

I guess we are all Bayesians updating probabilities as facts emerge. Each day the economic situation look dramatically worse than before, so in retrospect it's not surprising that market took such a drastic downturn.

Some of us see the facts earlier or update probabilities earlier. I am unfortunately one of the slower ones.

Week of 3/13/2020 - Market Melt Down. A New Era?

3/12/2020

The S&P index dropped 9.5%. The market was almost 30% off its peak.

The decade long bull market is officially over.

Throughout 2019 I consciously high graded my portfolio, away from the speculative micro/nanocaps into large caps. At the same time I capped my equity exposure to 80% through most of 2019.

I came into mid-Feb with equity exposure about 65-70% of my portfolio. Then the market hit. Now I'm roughly 60% equities - I sold very marginally, the reduction is mostly because stocks went down so much that they became a smaller percentage of the mix.

What now? I've sold most of what I wanted to sell. I still have some high growth, high multiple names that are liable to take a 70% drawdown, but I've cut them down to small size and readied myself to ride out the pain. (TTD, SQ, UBER).

I even added - very marginally - to companies that I think will not only survive a recession, but will come out stronger by consolidating weaker competitors.  Examples are GOOGL, ILMN, DIS.

So, What now?

It certainly looks like a recession is unavoidable. Indeed the U.S. faces a tough trade-off  - shutting down everything to protect public health means taking economic hits.

So why have I not cut exposure to 0 or even go short?

Some of this is almost Pavlovian - every time I cut in the past 10 years stock roar back higher. It got even more absurd in the Trump era - as soon as stock goes down 10% there's a Fed cut coming.

Shorts have lost every single time because of policy responses.

So what's the normalized valuation going forward? Any low growth company that's not totally cyclical can probably fetch 20x PE. As policy response grows stronger, I wouldn't be surprised if that number goes to 25x (and with fake earning add backs too as in stock based comp).

So I'm holding, under the assumption that the economy may enter a recession, but comes back in 3-5 years - with even more system leverage.

Why The Economy Might Not Come Back

What could go wrong is if the economy just don't come back. Maybe at some point we just can't borrow our way out of a recession anymore?

The trigger could be this reflexive intersection between markets and politics - as markets go down, the chance of Trump losing re-election increases. Imagine Biden wins in November and Democrats take congress, they will likely roll back the Trump tax cuts. Immediate hit to corporate earnings!

Government is already cracking down on big tech. You layer on more regulation and taxes...

Then we can look forward to a decade of stocks going nowhere.

For now though I'm still holding to my 60% equity exposure. I may regret it one day.


3/13/2020

Stock was going nowhere until the last 30 minutes of trading. Trump spoke in a press conference, and talked about telehealth (TDOC stock went flying as he speaks). Then he brought up Google (GOOGL goes up), then Thermo Fisher, then a steady stream of CEOs.

Then he talked about waiving student loan interest, and buying oil for SPR.

Stock went on a rampage toward the close. It was hilarious! A master class by the best stock pumping president ever!

It's as if Thursday never happend.

This is why I'm afraid of shorting stuff.

10x Genomics (TXG) and the Single Cell Revolution

The so called Next Generation Sequencing ("NGS") of DNAs is actually quite primitive. Traditionally it works in bulk methods, where every cell in a sample gets lumped together. Bioinformatic analysis of sequencing outputs thus essentially operate on averages. 

This is obviously a problem as each cell can be vastly different from the next.

10x Genomics ("TXG") does single cell sequencing. Its technology partitions a group of cells into individual cells, tags them, and then feeds the single cell DNAs into NGS machines (mostly from Illumina). The outputs can then be tied back to individual cells.

Scientists can now analyze cells individually and figure out how they actually work. This is more like science!

The stock looks insanely expensive and I'm hoping valuation would come down. 

For now though, I drew some diagrams below to show what I think the potential could be.

1.  Pre-single cell era. Various assays feed into NGS machines.  

2.  Single cell era (now and intermediate term). The single cell platforms, such as 10x Genomics, comes along and increasingly act as an intermediate layer between assays and NGS. 

This is mostly for research use, but can conceivably extend into clinical / diagnostics. In this diagram I have "Foundation Dx" on the right as an example of a diagnostic application that interacts directly with NGS without single cells.

Even within research, the single cell paradigm has a long runway ahead of it.

3.  The ultimate upside for 10x Genomics, of course, is the bottom diagram, where every assay, including diagnostics, go through an intermediate layer that partitions into single cells before feeding into the NGS machines. In this scenario TXG can get a valuation as high as (or even exceed) that of Illumina's. 

We should be close to TXG's IPO lockup expiration now. Between that and the current market melt down, I'm hoping TXG's valuation can become more reasonable.

Notes on Trade Desk's 4Q19 Call

Trade Desk ("TTD") had its earnings call last week. Here are a few things that stood out to me.

On Connected TV ("CTV") trends:

1. CTV adopts header bidding style mechanism. See below:

2. Since walled gardens don’t exist in traditional TV, marketers see CTV as a chance to shift power away from the walled gardens.

3. Even live sports are adopting CTV.

Financial/Modeling Related

1. Take rates likely to come down over next few years. TTD talked about willing to give up some take rate for market share. This is likely to trigger competitive response.

2. Deleveraging on the sales/marketing costs over the next  few years as TTD add more employees to capture growth market. 

• "you should expect sales and marketing to generally grow a little faster than revenue growth over the next few years"

3. Free cash flow suffered from massive working capital drain this quarter because the gap between DSO and DPO widened. It's not clear if that’s just temporary but management says they do want to bring it down.

• I can see this cash drain being a problem as their agency clients might turn into bad credits. 
• This also implies that some of that cash on balance sheet might not be excess as it is needed for working capital buffer.

4. 2020 revenue guidance implies deceleration through the year and exiting 4Q20 at mid/high 20's revenue growth. But management insinuated some sandbagging there

• "we're more comfortable moving expectations up as we go"

Overall I think the results are solid, despite some of my cautions on financials above.

Since my September post the stock went up from ~$185 to now ~$280. It may looks expensive but that's because the company has years of profitable growth ahead - it is winning in a large TAM that's yet to be realized. 

How many companies are growing revenue 30%+ while having TTD's SaaS like margins and positive free cash flow? Not only that, the Trade Desk achieves this 30%+ revenue growth while spending a mere 20% of revenue on sales and marketing. This is a rare asset indeed.

  

I continue to hold TTD as a way to capture upside on the Connected TV theme.