February 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 March 2017 the fund was down approximately 4.9% net of all fees and expenses. By way of comparison, the S&P 500 was up approximately 0.1% and the Russell 2000 was also up approximately 0.1%. Year to date the fund is down approximately 5.1% net while the S&P 500 is up approximately 6.1% and the Russell 2000 is up approximately 2.5%. Since inception on June 1, 2011 the fund is up approximately 116.5% net while the S&P 500 is up approximately 99.0% and the Russell 2000 is up approximately 77.4%. (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.
Our shorts really hurt us this month while our longs (collectively) had little impact. Despite this month’s awful performance, for the reasons outlined below I think there’s now much more money to be made on the short side of these markets than on the long side, and thus we remain net short. Here are the specifics…
In March I added substantially to our 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 0.78% at an average duration of 7.7 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 $124 billion a month (¥6.7 trillion + €60 billion [tapered beginning in April from €80 billion]), yet are long-term insolvent due to their massive liabilities. What will force the bond buying to stop (beyond the April taper)? For Europe I suspect it will be intense pressure from Germany in the face of U.S. tariff threats due to the weak euro or perhaps pressure from German savers, or it could simply be inflation. And when European printing stops (or even tapers), I think asset prices of all types worldwide (including, or perhaps especially, stocks) will correct heavily. (See our Russell 2000 short, below.)
Japan I think can never stop printing (its ratio of debt to GDP is too huge and growing too quickly) but will eventually crash the yen into oblivion (we’ve been short yen since 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 less than 2% a year (plus the yield) and as I see around 5% potential downside to this position (vs. our basis,n 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.
In March I also added substantially to our short position in the Russell 2000 (via the IWM ETF). I think this is a good hedge for our microcap long positions as well as an outright bet against what I perceive to be a dangerously expensive market, especially in the face of soaring auto loan defaults and a plunge in used vehicle prices that may be both a warning and a cause of a recession. Meanwhile, valuation is far above historical norms, measured by both a current PE of 138 and an EV-to-EBITDA ratio near 18x:
Again, I strongly believe that as Europe tapers its printing the liquidity that’s been keeping the equity bubble inflated will dry up and the bubble will burst. I can think of few better ways to profit from that than to be short this obscenely overpriced index.
Stanphyl Capital Letter continues below – skip to end to see small cap discussion