12/2018 Market Commentary


Like months past, December had a lot of news around Tesla, Musk, and sister companies. Here are some of the key items that caught our attention:


In case you were living under a rock or just returned from an off-the-grid vacation some place nice, stocks were down in December. What a month. We did say at the beginning of the year that counting on a repeat of 2017’s strong stock market performance was not a good bet. Our caution looked off for much of the year until October when the selloff began. It’s amazing what global central bank shrinking balance sheets can do to asset prices. Throw in rising interest rates, and you have a toxic mix. There are no current plans for central banks to stop the tightening, so stay tuned because the ride down will likely continue.


Much like our commentary earlier this year, we do not yet care for general price levels. We remain cautious and think you should be too. There are select opportunities though, and your team at Ballast continues to look for them.

Credit, Rates, & Commodities

Rates (10yr treasury) and major commodities continue to slide. Credit spreads have widened (risk premium increasing) substantially over the past few months. All of this has happened during what many pundits are saying is a strong economy. However, these things don’t tend to occur during a strong economy. Conversely, they tend to signal weakness. Meanwhile a portion of the interest rate curve has inverted, and an inverted curve commonly signals an imminent recession. Stay tuned.

Hindsight Capital

This piece is entertaining and provides a good perspective. Maybe someday Ballast will have the abilities to launch a hedge fund, Hindsight Capital.


Everyone is doing it. AB Inbev (parent of Anheuser Busch) and Altria (parent of Marlboro) have entered the cannabis fray. The former is forming a joint venture (pun?) with Tilray, a Canadian cannabis company, to research nonalcoholic beverages. The latter paid $1.8 billion to acquired 45% of Canadian cannabis company Cronos Group. There has been interest elsewhere in the market of large consumable goods as well. All relevant industry groups appear to be gearing up for a different future in the U.S. We think that future is coming but remains, generally, not investible.

China, What's Wrong?

Chinese companies have had great success raising capital lately through IPOs. What’s alarming though is that Chinese company IPOs in the US now exceed those in the mainland. Wait! What!? What’s wrong with China?

Buyer beware. And that means you too, index investors. Your index might contain things you otherwise might not want.


We discussed Netflix previously. Basically, this company spends billions more than it earns to rapidly buy up content in order to appease its subscribers (so they don’t go somewhere else). What’s weird though is that Netflix’s top viewed programs are content owned by others (see chart in middle of page). These shows are owned by other major networks – many of which are building out their own streaming services. If their own shows are not ranking well, then what’s the return on investment for Netflix owned content, you ask? Maybe when the Federal Reserve’s balance sheet is much smaller, we’ll find out.

Absurdity finds limit?

We wrote about SoftBank and WeWork in October, highlighting the high valuation the former has placed on the latter despite the lack of earnings of the latter. It seems absurdity may have found a limit. Key capital partners to SoftBank’s Vision Fund are balking at the latest valuation and proposed investment into WeWork.

CLOs & Leveraged Loans

We have previously discussed leveraged loans and CLOs separately. They are related markets – the latter invests in the former. There has been a lot of commotion recently.

Many market participants are shedding risk in the space.  In fact, some of these groups are beholden to investor redemptions/contributions (or fund flows in industry speak). Flow has been one way for a while, and now it’s going the other way – out. Another market participant, banks, have been unloading leveraged loans to protect their balance sheet. This is causing pricing to fall and discounts to grow.

By the way, banks have been happy to oblige the lending boom to date because the fees have been so good. This is a contributing factor to how you can get risk skewed too far the wrong way. But don’t worry, everything is fine.

This loan market dislocation can present good investment opportunities. Ballast continues to monitor the situation.

Two Things to Consider Before Investing in Individual Stocks or Equity Funds

It seems like no matter where you look, you’ll find an article (or two… or three… or more) about how the stock market either is going to continue to see bullish gains or about how it is edging closer to an impending correction.  There are many different opinions supported by a number of different facts and theses when it comes to this.  In fact, you may even have your own opinion based on how you feel the economy is performing and how certain companies will overperform or underperform in both the near and long term.



All predictions aside, let’s talk about value.  A potential and prudent buyer of a company (or part of a company) is going to do their own analysis and determine what they think the company is worth: VALUE. In determining that value, one will perform various amounts of research (finding comparable company transactions, discounting projected future cash flows, etc.).  We don’t want to elaborate too much on valuation theory though.


The point is that value can be calculated and determined, and there is science behind it.



Then, let’s talk about the amount you eventually have to pay for the company (or part of the company) if you determine you actually want to own it: PRICE.  Many times, the price you have to pay may be much greater than or much less than the value you calculated when performing valuation.


Let’s think about overall supply and demand in the US stock market today.  It seems that based on the overall higher prices, demand is outpacing supply.  So, who is buying?  Who is investing aggressively in the stock market, resulting in higher prices?  On one hand, it makes sense with projected economic growth, low unemployment, rising wages, etc. that investors would be buying at higher prices, expecting more income in the future.  On the other hand, with the baby boomer generation (who relies on fixed income) entering retirement, one would think that they would be selling equities and reallocating into more of a cash-producing fixed income “type” of portfolio.  This transition results in a lot of supply that might push prices down.


The point here is price is much more supply and demand driven, and there is less science behind it than value.


 What is the main point?

It is our belief that as prudent buyers, if you want to own equity in companies, determine value before you even look at the price of the company.  That is, determine the price you would be willing to pay for the value you’ll be acquiring.  Then, go out and see what the stock is actually trading for.  It might be priced at a discount, but in today’s world, it is probably priced at a premium.


If you want to see the wonder of stock pricing, watch the trading for a few days.  Prices of stocks go up and down sometimes for no apparent reason.  A stock may dip in price one week (sellers outpacing buyers) and could rebound the next week (buyers outpacing sellers).  But why?  Sometimes we think no one knows…


Which brings to mind the awesome scene in the classic movie Wolf of Wall Street where a seasoned stock broker (Matthew McConaughey) tells a new colleague (Leonardo DiCaprio) “…nobody, if you’re Warren Buffet or if you’re Jimmy Buffet, nobody knows if a stock is going to go up, down, sideways, or around in circles, least of all stock brokers.” 


The point we are trying to make is that there is so much going on in the market (speculative buying and selling based on what an investor thinks a company is going to make – or not make – in the future, short positions, hedging positions, company stock repurchases, insider trading, etc.) that it is hard to know when and why a stock is going to continue a bull run or if all of the sudden, the bears are going to hit it for a prolonged amount of time.  However, if you want to have equity positions in your portfolio, be careful, be prudent, do your analysis of value, and leave your emotions out of your decision-making process.

Our opinion is that there is a lot being paid for equity in publicly traded companies today based on tomorrow’s value.  The problem is that if you pay for tomorrow’s value today, you may be giving up the potential for exponential returns (e.g. 2 and 3 times your money in 5 to 10 years), which is something you should be hoping for in taking equity risk.

Market Correction? Yes. Buy the Dip? No.

The Dow Jones Industrial Average (“DJI”) fell from a high of around 26,600 on 1/26 to an intraday low of approximately 23,800 on 2/6, a downswing of 2,800 or 11.7% from top to bottom. By definition – typically considered 10% price movement – it was a “market correction”. We think “market correction” tends to carry an underlying investible opportunity connotation – a buy-the-dip moment. The January-February market correction was astonishing to most people, but not to Ballast because we looked at it quite differently. Here are some of the ways we put it into perspective:

Prior Performance

Year-over-year price performance of the DJI from December 31 of 1900 to 2017 yields another perspective. Index price returns for December 31 over the prior year-end from 1900 to 2017 generates 117 observations. For the year 2017, the index price return was 25%. This is right at the 20th percentile of observed returns. This means 80% of all the return observations were lower than 25%. For context, the range of returns were -52.7% in 1931 and 81.7% in 1915, all with a mean of 7.4%.


We consider the correction a modest giveback considering the generous returns provided up to January 26, and we would not expect an equally benevolent remainder of the year.


From the beginning of the year at 24,800 to the peak of 26,600, the index gained 7.2%. That annualizes to more than 86% (a level even the most bullish can agree is unsustainable). From the beginning of the year, the DJI was down a paltry 4% to the intraday low, and it was essentially flat by close of February 6. Remember, this was just one month into the year. There are no alarm bells going off here.

Days Not Years

To us, it hardly seemed like a market correction, or at least the buy-the-dip, investible variety. Each leg down in value, we looked back in time and measured the decline in terms of days, weeks, and months since the last time the DJI was at that price. In other words, the price gain that was eroded during the retreat. At its lowest intraday price of 23,800 during the correction, the DJI only retreated to November 28, 2017 price levels. To us, that is hardly a noteworthy movement. If anything, the reverse was true – the run-up from November 28, 2017 to January 26, 2018 was awesome. If the market had retreated more than a year we might be wowed and seek greater opportunity. What this highlights to us, and hopefully to you, is how uncharacteristically one directional (up) the market has been for the past few months and year. It was simply unsustainable, and so, the trend reset.


Think of the market as an intense workout. The athlete needed a break to cool down, but the athlete didn’t have a medical emergency. However, the media would have you believe the market was on life support.

Relative Strength Index

In fact, a popular technical indicator, the Relative Strength Index (“RSI”), which measures average price advances as a ratio of average price declines for a specified period, was at its highest level for DJI since 1904. We saw an internet commentator digitally overlay an image of a protractor on an index price chart with a caption that said, “just checking”. He was making sure the index price chart had not gone to 90° – straight up. It wasn’t far off. We found it funny because we held similar thoughts (a 2-year price chart shows increasing upward acceleration from November 2017 through January 2018). Some call this a “melt-up”, which is something common in late stage bubbles – yep, bubble. It happens as FOMO takes hold and indiscriminate buyers enter en masse.


No science here. Just look at it visually.

Buy the dip or revert to trend?

Earnings Breakeven

Another way we look at it is to ask how long it would take for an investor to recoup the lost market value in terms of earnings. (We prefer to think in terms of cash flow, but we’ll settle on earnings here.) The DJI constituents reported 1,240 in 2017 earnings per DJI “share”, according to Bloomberg. The 2,800 peak-to-trough price swing would take 2 ¼ years to regain through earnings. This is nothing to balk at, but the peak price-to-earnings ratio (“PE”) was 21.5x, a lofty valuation by historical standards. As reference, the DJI PE last saw those levels in the Dot-Com bubble. We would say, owning an asset at 21.5x earnings starts with expecting stable long-term intrinsic value, investing without earnings in mind, or expecting strong growth. In any of those cases, the 2 ¼ year breakeven should not now be concerning.