Investment Activity Review-August 2015

For many months I’ve been waiting for the market to literally crap out. I put my money where my mouth is and built up a pretty large short position on the S&P 500 index. It’s been a rough investment decision as thanks to the Federal Reserve and their low interest rate policy, stocks have been breaking records on an almost daily basis. August then arrived and it marked a turning point where investors finally began to question whether it made any sense to be in stocks. Ironically it wasn’t the Federal Reserve and the prospect of raising interest rates that triggered the sell-off. It was the sudden devaluation by the Chinese government of their currency that instilled doubts that the world economy was in good shape.

August marked the return of fear....extreme fear that is

August marked the return of fear....extreme fear that is

Stock markets around the world got ugly really fast. The movements were violent. The Dow Jones Industrials one one day opened down 1000 points. The CNN Fear and Greed index which captures investor sentiment was flashing Extreme Fear. My short position which before August was down almost 30 percent was now down only 9 percent. I figured that I would now being reaping the rewards for taking the other side of sentiment.

It is at these points of heightened volatility and fear, where I have learned and train myself to perk up and start looking for opportunities to start building positions in high quality companies that are getting thrown out en masse. Unfortunately the best times to follow the mantra of buying low is when there is fear and a downturn in the market. During the month, I was always going down my list of companies that I’ve always wanted to buy to see if anything is on sale. Despite the violent turns in the market, I still didn’t find very much to choose from. Stock prices were falling but not a point that made it enticing to jump in, however, I did make a couple of moves.

Opened position in Claymore S&P Global Water Index ETF (Ticker: CGW)

One of my long term investing themes revolves around water. The reality is with global climate change in full effect, I believe over the long run, there will be less water. In the US, it is already happening in the southwest. California and Nevada have enacted radical water conservation policies. I really believe that the next great conflict will be initiated because of water and not oil. In the past I have held various positions in water companies and ETF’s including the CGW. The past few years I haven’t had any exposure in my portfolios. CGW was having a good run and trading at the $30 level. With the recent pullback in stocks, the ETF fell down to the $26 range and I thought this would be a good entry point to build a position, so I pulled the trigger. I decided to go with an ETF like CGW because I really didn’t have the time to research individual water companies and out of the various water based ETF’s out there, it had a very diverse portfolio of global water treatment and utility companies compared to other ETF’s which had more US centric focus. I'm perfectly fine holding and building a position for a long period of time. 

Sold position in Neulion (Ticker: NLN) for 11 percent gain

If you just read the above heading you would think that was a decent return to generate from the stock. Unfortunately as we started August the stock up near 90 percent! The stock was hanging around the $1-1.20 range but then suddenly popped and was trading in the $1.70 level.  Analysts were throwing around a valuation in the $4 range. It was looking good. I was proud that I managed to hold on to the position for this long as I normally would have sold in the 20-30% return range. So what happened? Ironically with all the market meltdown it was actually a good old fashioned business event that triggered the collapse.

One of the big contracts the company had was with the NHL. Neulion had created and maintained the NHL’s online streaming infrastructure. It helped that the Chairman of Neulion was a former owner of the New York Islanders. It was a good gig and you think it would be good long term client for Neulion. Unfortunately it didn’t turn out that way as the NHL announced that it was severing their relationship with Neulion and instead was forming a partnership with Major League Baseball (MLB) to develop and managed the NHL’s online streaming prescence. The market hated it. The stock tanked 50 percent. When I heard about my reaction was, a baseball league was going to market a hockey league? How does this work? It just didn’t make sense. Then I started reading up on the agreement. It turns out that the MLB was going to pay the NHL royalties for its content AND also produce and distribute the content on behalf of the NHL. The MLB online platform has been crtically hailed as a standard for online streaming of sports and it appears that MLB has decided to monetize the platform by selling it other sports leagues. Neulion simply managed online streaming services. It didn’t own any content. The MLB/NHL deal turns that paradigm on its head.

For me this turned out to be a negative game changer moment. If Neulion could lose this type of contract, could this open the floodgates? Investors did not want to find out and sold on the news. The stock fell to about $1.05 and I faced a decision. Do I sell out now or do I hold on or add to the position to average down?

What’s interesting is the Neulion decision tapped into two key behaviorial finance concepts that I’ve written about in past articles. These concepts involve Loss Aversion (a tendency by investors to take on more risk when in a loss position) and the House Money Effect (engage in Loss Aversion behaviour when someone’s profit position is falling). In the articles, I illustrated the concepts using the decision I was facing with Neulion.

“Even though I was still up 25 percent and the stock had been down 30 percent at that moment on that fateful day, the thought crossed my mind to buy more stock, but I had been reading Thaler’s book at the time and this concept of Loss Aversion and I realized that if I actually followed through and decided to buy more stock, I would be feeding into this behaviour. So I decided to sell ¾ of my position and refrained from buying any stock. It turned out the stock fell another 20 percent on that day and so I managed to preserve a small gain. I remember though, that feeling of losing a lot of money, even if it was just on paper, was very unsettling. In the past, my instinct would have been to hold on to the stock and most likely buy more stock to lower my average (i.e. catching the falling knife)...”

“...I had a faced a situation that demonstrates this house money behaviour. I had owned a position in NeuLion and it was a very good investment decision as it was up nearly 90 percent so I had made a lot of money on paper. Unfortunately, the stock crashed but I was still up 25%. I decided to sell enough stock to cover my initial investment. The stock I had left was House Money. At the time I decided to do this because in my mind I could rationalize and live with the fact that I didn’t really lose money even though the stock tanked royally. The question that I faced was should I buy more stock at the lower price if fundamentals of company were still strong or sell the remainder of my position if it fell below my loss threshold which is 20 percent. Under the Loss Aversion behaviour that Thaler described, I would buy more stock even if the company has experienced a negative game changer moment and is a riskier prospect. With awareness of these types of behaviours, I decided to not buy additional stock and instead decided to ride the position out to see if the company could turn it around. If it couldn’t and the position fell another 20 percent, I would sell the remainder of the position...”

It turned out that a few weeks later, the stock fell another 20 percent from the $1.05 level that I initially sold my position. At that point I decided to sell the remaining position in keeping with my discipline for controlling losses. At the end of the day, I was up 11 percent on the whole experience. It could have easily gone the other way. I’m a bit disappointed to lose a lot of money (granted it was a paper loss), but profit is profit. I also take solace that my awareness of some key behaviors allowed me to take better control of my decision making, limiting what could have been a more negative outcome.

Added to position in Las Vegas Sands (Ticker: LVS)

LVS had enough bad things going for it before August; continuous falling gaming revenues from their Macau properties thanks to the corruption crackdown in China. Then the China stock market imploded in August which took the stock down with it. On the surface the optics continue to look bad for LVS, however if we’re looking for hope it is that revenues decreases appeared to be stabilizing and some analysts were looking for even some growth in the next year. The big thing for me was that despite all the negativity surrounding the business and the stock, the company is still printing money. Their returns on invested capital is still quite healthy and far exceeds their cost of capital. In addition their non-gaming revenues while not the core part of the business is growing. LVS and other Macau casinos are trying to broaden their experience by appealing to non-gamblers as well, much in the same light as Las Vegas did. At some point, the pendulum will swing back to at the very least the middle and at that point I think the stock will track up again. LVS one of the classic companies I always look out for; a company that can still create tangible wealth in a depressed market and that is selling at a discount. If they can make money in a bad market, what will happen to the stock when the good times return? It should pop. The question is when will gamblers come back to Macau? It could be awhile, but at some point I think they will come back.  With the pullback in August, I decided to add to my position in LVS to average down the cost. I would be willing to add more in the future if the same dynamic holds. The company isn’t going out of business tomorrow so it’s a type of stock I can hold for a long period. 

August was a month that I have been waiting for a long time. I faced some decisions that challenged some behavioural biases that I've built up, but I think I was able to manage it effectively. While I would have liked to buy some more companies, the reality was they were not in my comfort zone, so it was important that I stayed discipline to my strategy. Just because the market is tanking doesn't mean you go all in on stocks. Opportunities will always come up. It's disappointing to see a good chunk of change taken out on the Neulion position but a profit is still a profit. You take it and move on fast. At the end, you still have to execute your plan on your terms. I expect to be checking my list more frequently given the volatility in the markets and hopefully will get a chance to go shopping for some deals.