April letter from Stanphyl Capital. The hedge fund was profiled in our second edition and returned 31% in 2016. Check out the post and especially the end of the PDF for more on their small cap stocks.
For April 2017 the fund was down approximately 4.4% net of all fees and expenses. By way of comparison, the S&P 500 was up approximately 1.0% while the Russell 2000 was up approximately 1.1%. Year to date the fund is down approximately 9.3% net while the S&P 500 is up approximately 7.2% and the Russell 2000 is up approximately 3.6%. Since inception on June 1, 2011 the fund is up approximately 109.7% net while the S&P 500 is up approximately 101.1% and the Russell 2000 is up approximately 79.4%. (The S&P and Russell performances are based on their “Total Returns” indices which include reinvested dividends.) As always, investors will receive the fund’s exact performance figures from its outside administrator within a week or two.
As in March, our shorts killed us this month while our longs (collectively) had little impact. I thought April’s €20 billion ECB taper would be enough on the margin to start deflating a worldwide asset bubble that—by many metrics– was topped only in 1929 and 1999-2000; I was wrong. Despite ridiculous equity valuations and signs of a U.S. economic slowdown via increasing defaults in auto loans & credit cards and an awful Q1 GDP number, worldwide central bank balance sheet expansion may still be too massive to fight in significant size on the short side. Although the S&P 500’s current Shiller PE is an absurdly high 29, one must acknowledge that it hit almost 33 just before the 1929 crash and 44 just before the 2000 crash, and in neither of those instances were central banks printing over $100 billion a month (in 2017 dollars) as they are now, nor were major worldwide real interest rates almost universally negative. Belatedly acknowledging the possibility that this market may grow from the third-biggest bubble in history (as measured by Shiller) to the “first biggest,” in April I covered our Russell 2000 short position (fortunately, mostly before the French election) while maintaining our shorts in non-US sovereign debt (“the bubble that enables the other bubbles,” via our BNDX short), and—in reduced size– in Tesla (the market’s biggest single-stock bubble, with so many red flags that it could—and should– collapse regardless of what the broad market does). Once significantly more ECB tapering is at hand I may again put on a broad-market short position; alternatively, if we get a major sell-off prior to that we’ll have plenty of liquidity to buy when others are glued to their “sell” buttons.
Meanwhile, beginning this month (April) I’m waiving the fund’s 0.5%/year management fee until we’re back above our high-water mark. (We’re currently approximately 9.3% below it.) I didn’t do this when we drew down 17% between 2014 & 2015 because we had lots of deep value longs then that I felt would take off and make us a lot of money (and they did in 2016, when we were up over 30%). But on an “absolute value” basis (I don’t play the game of “relative value”) I’ve yet to find any cheap new long positions to add this year (which tells me how overvalued this market is), and don’t want to charge a management fee in a down year while positioned defensively. Here then are the fund’s positions…
As noted above, we continue to hold a short position in the Vanguard Total International Bond ETF (ticker: BNDX), comprised of dollar-hedged non-US investment grade debt (over 80% government) with a ridiculously low “SEC yield” of 0.74% at an average effective maturity of 9.2 years. As I’ve written since putting on this position in July 2016, I believe this ETF is a great way to short what may be the biggest
asset bubble in history, considering that Europe and Japan (which comprise most of its holdings) are printing approximately $115 billion a month (¥6.7 trillion + €60 billion, yet are long-term insolvent due to their massive liabilities. When will the bond buying end? For Europe I suspect it will be when the current ECB commitment expires at the end of 2017 and isn’t renewed, thanks to German pressure due to U.S. tariff threats, struggling savers & insurance companies and “enough” inflation. In fact, Eurozone inflation is now surging. Japan I think can never stop printing (its ratio of debt to GDP is too high) but will eventually crash the yen into oblivion (we’ve been short yen since late 2012) and with that its bonds will crash too. (I discuss Japan more extensively in the last paragraph of this letter.) The borrow cost for BNDX is just 1.6% a year (plus the yield) and as I see around 5% potential downside to this position (vs. our basis, plus the cost of carry) vs. at least 30% (unlevered) upside, I think it’s a terrific place to sit and wait for the inevitable denouement.
Ticker and other info removed for non subs or one stock – this stock and 3 more small cap tickers below for subscribers
We continue to own XXXXXXXXXXX maker XXXXXXXXXXXXXXXXXXXXXX which in March reported a somewhat disappointing FY 2017 Q1 (its seasonally weakest quarter) with revenue down 6% year over year and a small operating loss ($6X,000) vs. $23X,000 in operating income a year ago. However, the company did generate almost $5XX,000 in free cash flow and seems to have turned its international division around nicely, with solid growth from its XXXXX acquisition. More importantly, XXXXX has hired an investment bank to “explore strategic alternatives”—in other words it has put itself up for sale (and also paid out a .70/share special dividend in February). Thanks to its 53% gross margin and potential for large SG&A eliminations if it weren’t an independent public company, I think XXXXX should be sell-able to a strategic buyer at a significant premium to the current price; for example, an enterprise value of 1.25x 2016 revenue would be roughly $12.65/share (net of the cash paid in the February special dividend), while a “worst case” scenario of 1x revenue would still be around $10/share.
Stanphyl Capital Letter continues below – skip to end to see small cap discussion