Friday, April 16, 2021

Things that happen in manias

 This is a funny story.  When we have this sort of buoyancy in markets all sorts of securities trade at absurd valuations.  David Einhorn apparently featured, in his letter, a business with $35k in revenue and no real assets, that has $100m valuation.

Hometown International, NJ deli owner, worth millions in stock (cnbc.com)

I recognize that sometimes this sort of valuation is possible in markets that trade infrequently and in which a few shareholders control most of the shares, ensuring that funny bids or asks or unusual trades of de minims shares can then be extrapolated over a large, but illiquid share count to arrive at confusing valuations.

A better, albeit perhaps less extreme examples is ELLH, which deserves a longer discussion.  I believe it might be the worst equity security I have found, certainly in the diversified holdco space.  You deserve a full accounting of this one, not because you will want to invest, but because it is a poster child for what really happens with many of these "triumph of hope over experience" firms; the holdco with small tangible asset base, but laden with huge NOLs from an operating business - often discontinued - operations, leaving management with the challenge of lacking an operating base that can actually earn the profits that enable those assets to be used before they expire, and few strategic options for doing so.  Indeed, I believe that the NOLs may cause management to behave in foolish ways because of the endowment effect of wanting to preseve those assets, sometimes at the expense of feeding the new or remaining business (raising external capital can limit the NOL recovery and so management may force the company to internally finance growth).

Anyway, this is a larger topic for another day, but it is a counter-example, I think, to the Klarman view that there are no bad assets, just bad prices. I get his point - free options are just that.  But the endowment effects on the free option holder; the desire to make something of that option, can warp the perception of how to grow the greatest aggregate value.

In any case, everywhere I look, I see high prices and low returns.  I suppose there is a real possibility that we will see huge inflation and that operations of firms will be able to grow to justify today's valuations, but today's valuations won't have moved much and the purchasing power of those assets will be greatly diminished, so the "richness" will be nominal only.  More likely, we will get a period of pricing weakness, though not so long as we are in "lockdown"; imprisoned but working upper middle class types are experiencing incredible savings rates that are fueling this market surge.  The end of lockdown might actually see a decline in transfers into brokerage accounts, so ironically, economic growth might actually hurt equity prices.

It's a very tough time for someone to have a consistent strategy, in part because the strategies that have worked pretty consistently since the 1940s, are not set up for what we are about to experience.  The "normative" experience of US equity markets might be much more of an outlier than we think.  Japan, mid-century Germany, revolutionary Russia, revolutionary China; all of these places have experienced really catastrophic results where buying the dip didn't put you on a glide path.

But in a speculative mania, where money and profits seem pretty effortless (and I will admit that nearly all of my investments have been working but I have been raising cash) it is very hard to take money off the table.  Also, if we truly do get inflation, short duration assets will struggle; especially if we have policymakers engaging in financial repression on yields of short term instruments, as seems likely.

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