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The 2012 Recap – Part 2
Posted By Jeffrey Dow Jones On December 20, 2012 @ 8:41 am In Newsletter | Comments Disabled
In case you missed it, here’s part one  of our annual recap.
We’ll jump straight in to part two.
Well, I guess, technically, the Dollar was strong in the sense that it held in there. By July this forecast even looked brilliant. But the Dollar softened up a bit in the second half of the year, trading right back down where it began the year.
Along with my Dollar prediction I had a few tangential calls. I thought the Australian Dollar would weaken (it didn’t). I thought the Peso would be particularly strong (it wasn’t). And I thought the Loonie would have a great year (it sorta did).
It wasn’t a great year for guessing the right currencies. I was correct about abandoning the bearish views that had been dominating the mainstream for the previous year. But the Dollar just kinda held in there through 2012 instead of building much on the strength we saw towards the end of 2011. There’s a chance more of that strength is still to be seen in 2013, however.
LESSON: Within this failure there’s a good lesson. Currencies are incredibly difficult to predict. That’s nothing new, of course. But we forget that irrational Dollar pessimism is a prediction, a prediction that the Dollar will fall apart. That’s something to keep in mind the next time you get panicked about Q-Infinity or whatever. What appears to be an ironclad thesis in the world of currencies rarely materializes as such.
Currency markets are immensely powerful things and I think investors are better served using currency analysis to avoid the nations with the largest risks rather than trying to pick the ones that will outperform. An understanding of currencies is much more helpful towards protecting your capital and having it parked in the right places than it is for growing it. I’ve never heard any analysts frame it this way, but I think this is an important, subtle point.
Don’t try picking the currency winners, just worry about avoiding the losers. That’s good enough.
Sometimes I get things technically correct but still feel as though I missed the spirit of the call (eg. the Canadian Dollar).
And sometimes I get it wrong but feel like I got the essence right. That’s sorta how I feel about this one. At the beginning of the year, you couldn’t have assigned a greater than 10-15% probability of Mitt Romney becoming president. By October, that probability had more than doubled. Depending on where you get your news, Mitt Romney winning may have even been the more likely outcome!
When I made this prediction, Romney had just passed up Newt Gingrich in the polls after spending 6 weeks behind him. Before that he had trailed Cain and then Rick Perry. By the end of January, Newt was back in the lead. A few weeks later, Santorum came out on top (sorry) and it looked like he was going to be The Guy. The field was in flux.
In retrospect, the whole thing looks like a fait accompli. Of course Romney was going to emerge as the GOP candidate and of course he was going to lose to Obama. But he did emerge and came closer than most (sensible individuals) expected. This still qualifies as a sufficiently outside-consensus prediction.
I thought Obama’s goose would be cooked for reasons largely outside his control (a faltering economy). But the economy was just strong enough and he was just successful enough at convincing enough folks in the middle that the status quo trajectory was preferable to the alternative.
LESSON: When it comes to politics, listen to objective data and not partisan-biased narratives. I mean, that was a pretty big lesson this year, right?
We all learned that one, didn’t we?
When I made that original prediction natural gas was trading around $2.30. Yesterday it closed at $3.34. That’s a gain of almost 50%!
Natural gas prices are a rocky ride, as any old-school commodity trader will tell you, and it’s likely you wrote this forecast off as a bust in April when prices dipped under $2.00. But this was a secular call and it’s one I expect to remain relevant for the next several years. This, along with real estate, is a legitimate bright spot in the economy right now. Natural gas will be an increasingly important resource for the U.S. and 2012 was the year where a critical mass of people began to understand that.
This was also the year where the natural gas story narrative kicked into high gear. At the start of the year, few outside of the industry core were paying much attention to natural gas, and those that were were almost apocalyptically bearish because of the extreme oversupply. Today the dialog is everywhere and our energy future looks a whole lot less bleak than it did during the “peak-oil” days of 2007.
If you paid attention to our commentary this year on natural gas it was a call that helped you sound smart and make money.
At present, this is one of my favorite sectors to invest in and around. It’s going to be a long-term story, too, an important part of the U.S. economy for the next decade and a possible solution for problems both environmental and economic. Expect continued infrastructure buildout and expect continued technological development — maybe 2013 is the year where the dialog starts seriously including things like LNG-powered big rigs. It’ll cost money to get a network of filling stations in place and it’ll cost money to get these trucks retrofitted. But there are serious cost savings to be had as well as a smaller environmental impact. (Natural gas is much cleaner burning than oil, gasoline, or coal.)
And expect the political debate to continue. There’s a lot of stigma and scary stories swirling around hydraulic fracturing. Ask any energy company: this is nothing new. It’s normal (and proper) for people to feel nervous about the impact of new techniques. So along with continued development of this sector we need to adopt some sensible rules and regulations. Nobody worth listening to will disagree with this.
There’s a legitimate middle ground, here, one where we are able to take advantage of an inexpensive, clean-burning fuel that we own in great supply while at the same maintaining a pragmatic attitude of sensitivity toward our environment. This is an area where government can, and should, play a role in oversight, while keeping its eye on the greater economic prize. As cynical as I am about politics and governance, this is actually something that the U.S. has demonstrated tremendous aptitude for throughout the last 50-75 years, at least relative to other nations. We’re better than we think when it comes to environmental/economic compromise.
LESSON: Big energy companies are really smart. No, seriously. When you see them making significant investments in re-designing their businesses and re-structuring themselves around new and different growth areas, you should pay attention. Most energy and commodity analysts were fixated on collapsing natural gas prices and most of the mainstream was fixated on the political debate over fracking. But all the money in the industry was moving towards laying down infrastructure for a future that is more reliant on natural gas than it had been in the past. This year, natural gas was a reminder that if you follow the Really Big Money you’ll often be glad you did.
Why do I try? Why???
Sometimes even a blind forecaster hits a home run.
Let me just reprint what I wrote at the start of the year:
If Groupon is a $12 billion company then I’m the King of Spain.
This is a space with zero barrier to entry. It’s a race for zero margins. It’s a battle of increasing risk and expense.
I think Groupon takes a lot of heat in 2012. I think it’ll be a hair-raising ride for investors. Groupon is getting heavy pressure from chief competitor LivingSocial, and in the coming year they’ll have to also respond to Google, Amazon, and Facebook. To stand up to those guys, Groupon is faced with a nasty Catch-22. In order to grow, they have to increase marketing costs or reduce what they charge merchants. But if they increase marketing costs or reduce what they charge merchants, their earnings take a hit.
One the one hand Groupon is faced with “impacted growth.” On the other hand, “impacted earnings.” Companies with strong balance sheets, good cash flow, and powerful brands can manage those challenges. A freshly IPO’d stock like Groupon, whose current multiple is contingent upon both more growth and better earnings, seems destined for a spanking.
I could probably go on all day about all the reasons I think it’s a terrible investment. In fact, my friends & family on my Facebook feed have been listening to me rant about this for almost a year now (sorry guys!). The bottom line is that this company’s existential crisis could come as soon as this year. The market will probably not react favorably.
I know that all sounds really obvious in hindsight. BUT. After Groupon IPO’d, opinion was almost unilaterally bullish. Nearly every analyst had it listed as a “Buy.” The stock closed last year at $20 after a $16 billion valuation on Day One.
Today it trades at $4.93. Today it’s a $3 billion company. That’s half of what Google offered to pay for it, back when Andrew Mason gave them the finger and said, “nah, we’re worth twice that.” Somewhere Larry & Sergey are laughing.
LESSON: Great opportunities to go short are tougher to find than you’d think. Groupon was a real doozy. One of the best lessons I learned in all of 2012 was Doug Kass’ brilliant philosophy on shorting. ”Never short a concept or a valuation. Instead short business models that are broken.” This year gave us one of the most perfect examples of that in recent memory.
There’s another lesson here, too, taught most elegantly over the years by Yahoo, and that’s to never underestimate the power of a large following. There is honest value in 33 million active users. As bearish as I once was on Groupon, I don’t think it’s destined for zero. Somewhere inside Groupon is a real business and real value. It’s obviously not a $12 billion business and it’s not the business it went IPO with. But maybe it’s a legitimate $1-2 billion business. Its success or failure as a company now rests entirely on the shoulders of management to figure out just what in the heck that is.
And there’s one last lesson. Somewhere along the line, IPO’s changed. They stopped being about raising capital to fund new growth and became more about rewarding employees and private shareholders. We’ve seen it with pretty much all of them from Pandora to Facebook. Mark Zuckerberg even spoke to that point directly in the reasons why they finally went public (to compensate workers expecting an eventual IPO bonus). Groupon was perhaps the most extreme example of all this: sell just 10% of your shares on the market, get a crazy valuation, make your early employees and VC investors hojillionaires. This is something to watch for the next time IPO activity picks up. Ask why these companies are really going public. How much of their shares are they selling?
The market for private capital is much more evolved today than it once was. Good startups can get all the cash they need without going public. This too is probably another side effect of negative real interest rates and a global desperation for yield & ROI. The VC/PE space is as hungry for good deals as ever.
In retrospect, I feel really good about these how these predictions concluded. I got 6 right and 4 wrong, which isn’t too shabby considering that many were decidedly outside-consensus predictions.
There’s an important point to be made about making forecasts, especially since the time to do it all again is drawing near. If all you do is look at the current trend and blindly carry it out through the future, you’re going make people think you’re smart when you’re really not and when you make mistakes you’ll be able to point to everybody else and have the safety of saying that everybody else missed it too. Perhaps that’s why so many analysts make predictions that way. Job security. But it isn’t very helpful for investors, nor is it very interesting.
One of the greatest investing lessons I ever learned came from paypal-founder and famous Facebook investor Peter Thiel at an event I attented many years back in New York. He told us that the way you make BIG money in the markets is by being contrarian but also by being fundamentally correct. It was an idea that really stuck with me.
As an investor, I tend to be the kind of guy generally content to hit singles. I like to make high probability bets and I like to spread them around. I’m the kind of guy who doesn’t feel insecure with a high-Sharpe 5-7% portfolio when all my buddies invested in the market brag about making 15% that year. But I always have my eye out for truly contrarian opportunities. You don’t make big money investing alongside the rest of the world. You do it by being right when the rest of the world has it wrong. There’s always a corner of my portfolio where that sort of thing is welcome.
This year, I feel like my process evolved in a meaningful and advantageous way. I set out first to define a highly-probable backdrop and then make some forecasts around that backdrop, particularly where there were divergent stories being told by the fundamentals and the conventional wisdom. The ones I got correct — the stock market, calls on real estate, China, natural gas, and Groupon — were predictions where the fundamentals were suggesting one thing but the conventional wisdom suggested the opposite. The fundamentals ultimately contradicted the prevailing psychology.
Those were the most actionable calls, too. As an investor, I didn’t take action on them (again, just because that’s not how I usually invest), but if I had, I would have done all right.
If anything, this whole exercise is a reminder of the idea that process matters. If your process is good, and you focus on making that process better and better over time, you’ll get a more favorable distribution of outcomes.
That’s a powerful lesson upon which to conclude 2012.
Next week is Christmas! I hope that the 91% of you Americans who celebrate that holiday have an awesome week. It sounds like we’re even going to get a White Christmas up here in the Sierras, too. But I’ll be on the road for the next few weeks visiting family and friends in southern and northern California, before convening for a mini family reunion of sorts up at Lake Tahoe. Hopefully there’ll still be some snow to go around.
I hope you guys have a week full of warmth, love, and delicious foods and holiday beverages of your choosing!
Article printed from Cognitive Concord: http://cognitiveconcord.com
URL to article: http://cognitiveconcord.com/2012/12/20/the-2012-recap-part-2/
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