Correction Time

The S&P and Dow are both down 10%+ from their recent highs.

Despite my large cash balance, I am also down about 5%; in part this is due to my over-exposure to the energy sector.

Volatility has been resuscitated from its death bed. While there is nothing to be super-excited about yet, let’s just say, things have started getting interesting.

Here are some resources to put things into context”

  • A Field Guide to Stock Market Corrections: The base rate of a 20%+ bear market given a 10% correction is 50%. Thus, the odds of a continued decline in the market, or a recovery are about even.
  • What Past Market Declines Can Teach Us: 10% corrections are quite common; they occur about once a year. When they don’t deteriorate further, they take about 4 months to heal. 20% declines are also surprisingly common; they occur about once a leap year. On average, they take an year to climb out of.
  • Putting Pullbacks in Perspective: There have been three declines of 40% or more since 1945. They have taken about 5 years to recover from. Longer bull markets (time since last 10% correction) lead to deeper stock market losses. Based on the length of the current run (about 1.5 years), the regression line (in the linked article) suggests that we should expect a pullback of about 15%.
  • The stock market over the last 200 years: This article from Basehit Investing always provides a valuable lens with which to see any current market turmoil. Volatility is a natural part of the stock market. Patience is key.
  • Testing Times: Aswath Damodaran takes a deep breath, and takes a clinical look at the underpinnings of the current market conditions.

For some reason looking at numbers, and zooming out to see the bigger picture in times like these is helpful. It prevents my reptilian brain from retreating in panic or doubling down in hubris.

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Portfolio Moves: Sold Apple

After 4.5 years, I finally closed my Apple position last week.

I started buying in early 2013 in the low $60s (accounting for the 7 for 1 split). In 2016, I added to the position in the low-mid $90s. For quite some time it was my largest or second-largest position.

apple

No matter how conservative I got, I couldn’t come up with a value below $120. Last fall, I wrote:

The narrative is either “its going gangbusters” or “its going down the toilet”. Right now, we seem to be closer to the latter.

The narrative shifted over the past year, as Apple racked up an impressive 80% run.

As usual, I began selling way too early ($120), and finally exited my last sliver on November 10 at $175. Overall, my cost basis was $71, and my average exit price was $130 and change.

Counting dividends, Apple returned between 18-20% CAGR. Not spectacular, but considering the size of the position, and its relative safety (in my opinion), it is my kind of long-term trade.

At current prices of $175/share, AAPL doesn’t seem to be as great a value.

Why?

Last year, Apple earned about $9/share. It has about $31/share of excess cash. Using a conservative 12x multiple on the earnings, and a 20% repatriation haircut on the excess cash, I get a valuation of about $135. If you use a 15x earnings multiple, you can justify paying up $160.

I don’t know what the right multiple is. I hesitate using a high multiple because (i) Apple relies heavily on the iPhone, which regardless of how the winds are blowing currently is subject to disruption/erosion, and (ii) earnings are starting to saturate/grow more slowly.

I don’t think AAPL is grossly overvalued. However, I prefer to sit this one out.

Apple might quite possibly march onward to become the first trillion dollar company. I’ll be happy to watch the fireworks, and cheer on from the sidelines.

Portfolio Activity

This year – so far – has been unusual.

Long Positions

I haven’t bought many new positions, except for the following.

  • increased my Oaktree Financial position by 33% at the beginning of the year for $40 (put got assigned)
  • doubled my position in Fairfax Financial around $435/share
  • started building a position in ALJ Regional holdings. Currently I am 1/2 or 2/3 full, at an average price just below $3.20.
  • bought a slug of IBM after the latest disappointment.

Consequently I am about 35% in cash.

My largest positions are “financials” BRK (15%), LUK (10%), FRFHF (8%), OAK (7.5%), and WFC (6.5%), and account for nearly 50% of my invested portfolio.

Options

I have been been trying to educate myself about using options more opportunistically. It has become a new weapon in my arsenal. It fits perfectly as an overlay to a long-term value investing strategy.

At some point in the year I’ve embarked on months-long cash secured put campaigns  on:

I’ve had shorter lived positions in HBI, FSLR, and NOV, in which the position moved away from me rather quickly.

I currently have open CSP positions on UA, GME, DIS, FAST, MSM, and STX.

Between 2010 and 2016 my total “income” from dividends and options increased from $3,000 to $9,000 (yield between 2-3%). So far this year (2017), I’ve generated about $18k of income from options and dividends, and feel reasonably confident about hitting $25k by the end of the year (yield >5%).