Many of you know that MCS is a family office that manages our own liquid money in exactly the same manner as our clients. We use strategies that were developed decades ago, along with a decade long track record as evidence of our returns. In speaking with investors, we find they usually take a very short term outlook. Thus, today is a good day to discuss the- “Why we do what we do” part of the MCS story. It is a personal story, so please bear with us. We will start with how one of the founder’s acquired wealth- basically in diverse asset classes: Technology, Banking, and Commercial Real Estate and in the Stock Market through investing in ETF’s. We believe that our personal story is relevant to all investors and highlights both the importance of cycle theory and using proper analysis when investing.
Let’s begin with the technology piece-The family had a business as a manufacturer’s representative for major companies such as: Mitsubishi, Samsung, a division of Texas Instruments and other companies too numerous to mention during the 30 years this company existed, roughly from the years of 1970-2000. The timing couldn’t have been better since this was an era deemed the economic summer and fall. The semiconductor was developed in 1978, and selling components during the technology expansion propelled the company forward, with great success until about the year 2000. Then the cycle ended, technology became a bubble, stalled and busted. The signs of the bust were evident in the fundamentals and the economic indicators as the era progressed. Fifteen years later this asset class is barely back to even. If the family did not ‘exit’ this asset class, and move on it would have been disastrous for both protection and wealth acquisition. The tech company was closed debt free-we kept the profits.
On to banking, the family started a bank with 12 other local investors in the 1980’s-a prime time for local bank expansion in the DC area and also during the era of economic expansion. The 1970’s era of stagflation-(inflation in times of slow economic growth) was over and interest rates were sky high, with many homeowners taking out mortgages at 10-17% interest. These were halcyon days for most banks. The bank survived the real estate crash in the early 1990’s and was acquired by another bank; and ultimately acquired by BB&T. BB&T is the 12th largest U.S. bank by deposits, is not an investment bank and did receive a bail out or free FED money during the 08-09 crisis. BB&T stock is still down approx. 30% from the meltdown and has little hope of fully recovering until after the last leg of this cycle is complete. The BBT dividend was also slashed in 08, (as were most other bank dividends) and has not recovered to pre-crisis levels. In fact, what is left of the dividend may be in jeopardy in the future, should ZIRP and NIRP policies continue. Our family divested of this stock primarily during 2005, due to fundamental analysis; combined with the economic indicators foreshadowing a meltdown in the market. The banking industry was increasing predatory lending practices in 2005, with these loans being securized and sold to the unsuspecting public- also a good indicator of what was to come. Our selling was prescient as the chart of BBT below illustrates-holding would not be conducive to building wealth.
Your bloggers were working at Citigroup/Smith Barney during most of this time, and in 2005, and we shouted from the rooftops to anyone working at the firm that would listen, to sell their Citigroup holdings-very, very few employees sold their stock prior to the meltdown. The chart of Citi stock below from 2005 to present, shows the stock is still down over 90%. The 2008-09 timeframe ushered in the end of Smith Barney and other companies including Lehman and Bear Stearns. The abrupt shuttering of these companies is only part of the story of long term wealth destruction. Most employees in the financial industry working at companies from Merrill Lynch (which was bought by BAC) to JPM and across all areas of the industry and these employees lost the majority of their own liquid net worth. We left SB in 2007, and started our own RIA to be able to run our loss avoidance and appreciation strategy unconstrained by a company that ultimately is no longer in existence. Just consider the irony-these companies were telling others how to manage their wealth, but couldn’t even manage their own companies or individually, their own net worth. Not to be trite, keeping your wealth intact is always the first priority. The Citigroup stock chart below is from 2008 to present. Notice the $500 price in ’08 which was adjusted for the 10 to 1 reverse split.
There is little to say about our family commercial real estate holdings. We are holding these assets extremely long term; we hope they will prove to be multi-generational. They fluctuate vastly in value with the commercial real estate cycle and we don’t expect them to add appreciation for years, until economic spring emerges again. Basically, there are two things we can advise anyone in the commercial real estate business to practice: keep your debt manageable and acquire the best tenants you can to keep your cash flow, flowing and positive.
This brings us to the last part of the story-money management. Using cycle theory, combined with fundamental and economic analysis; our family was able to exit several businesses and keep the cash. That principal has more than doubled (from 05-present) by investing in the MCS strategy. We intend on doubling this principal this again and again, throughout the full cycle using the same strategy. We were able to avoid one of the most common mistakes in investing-losing money. Many investors also mistakenly believe that ‘their’ industry will stay on top forever. This situation can be evidenced again today with investors both working in and investing in the oil and gas industry- watching their holdings fall or their companies go bankrupt.
Over the years, we have evaluated many money management strategies and continue to evaluate strategies in the industry using professional databases like Morningstar, PSN Informa, Prequin and others. Most strategies have the exact same Achilles Heel that Warren Buffet has; when a strategy is fully invested, the investor must be able to stay the course even when his investment drops 20, 50 or even 80%. Buffet’s BRK fund dropped more than 50% in ’08, and is down 12% gross of fees in 2015. In addition, BRK has less than a 3% annualized rate of return since 2008. Buffet may be considered the Oracle of Omaha-but we simply don’t have the stomach for that type of volatility for our liquid assets. We prefer to invest in safe periods and move to cash during risky times, writing options to bring in income. At the end of the day, there are some managers with long term track records that have similar 10 year annualized returns to MCS; albeit with much greater downside volatility. We prefer portfolios with greater stability, which allows the portfolio to compound returns over the full investment cycle. The results of compounding are amazing, but one has to wait to experience the results. Compounding is one of the main tents for ‘real’ investors. Many people make money in their lifetimes, but our research shows, scant few can keep it and even fewer compound returns. This chart of Berkshire Hathaway is from Oct. of 2007-present-illustrating the downside volatility. BRK is highly correlated to the U.S. equity market and should be expected to drop when the equity markets decline.
MCS often discusses the media and the role it plays molding investors’ minds. The media was complicit in the move to ‘push’ tech stocks, banking stocks and now bio-techs and pharma just before downturns. As promised on June 15, 2015, in the blog titled, “Why MCS May Completely Disagree with Your View” we promised to return to the mutual fund PRHSX from T Rowe price that was pumped to the public through Washington Post articles and on the radio program WTOP. Here is the performance of the fund today, after many common investors entered the fund that was once only available for institutions. PRHSX chart is from April of 2014 to present, down about 22% approx.
Guess who exited this fund when the new (public) investors entered? Yes, the common man who ‘heard’ the good news, and jumped in too late. This fund was heavily invested in Valeant Pharmaceuticals; symbol VRX, among other ‘suspect’ Healthcare high fliers. To quote Money Morning reporter Michael Lewitt, “VRX is one of the biggest shorts for 2016, the stock has fallen over 37% since the start of the year….This Company has been rocked by a series of drug pricing and accounting scandals, (does this bring back Enron and WorldCom memories in a familiar scandal pattern?). Now Valeant’s last line of defense- the sell side analysts- are finally abandoning it and the stock will continue to free fall. Anyone who thinks this is a good time to get in at a discount should quickly re-evaluate and stay away.” Sell side analysts are the brokerage firms for those that are not familiar with the term-and the story gets worse. The Valeant stock chart is from Jan 2015 to present showing an approx. 75% loss from the high last September.
At least one of the sell side company analysts sent out a ‘research note’ in Dec with a $250 price target on VRX stock. As you can imagine, many brokers then ‘sold’ this stock idea to their clients. In our opinion, the Pharma and Biotech stocks could become a scandal as big as the Jack Grubman (analyst from Citigroup/SB) scandal in 00-02. For those with short memories, Grubman continued to push buy ratings to the brokers at Smith Barney all during the tech meltdown and ultimately was banned from the industry. Of course he was ushered out with a large severance package while the SB clients lost massive money in stocks as varied as WorldCom, Lucent, Enron and others. It seems that investors continually fall for the same old tricks when looking to make a quick buck. Since no one has a crystal ball; it is important to use facts not feelings when you are investing. Stocks always revert to the fundamentals, especially after times of outrageous valuations. Investors that use fundamental and economic metrics are more likely to keep money and be able to add appreciation over the long run, which is the basis for sharing our own personal story today. We find many investors are much more interested in the short term when focus should be short, to intermediate and most importantly long term; while the investor keeps all three timeframes in perspective. Investing is long term in nature, and acquiring profits in the short term is useless if one does not have a mechanism to keep the profits. We trust our personal story will motivate your use of cycle theory in the business areas and investments you choose for the rest of your life. Across the world, investors are ripe with stories of huge profits, only to be wiped out when the cycle changes. Personally, cycle theory has ‘saved our bacon’ many times. However one acquires wealth, it is essential to protect and grow that wealth. The media and financial industry continue to tantalize investors with the profit side only, always minimizing losses.
In other news today, Sports Authority filed for bankruptcy yesterday. This should not come as a surprise, since the retail cycle is in a downturn along with the economy. Many more retail establishments will file for bankruptcy in the coming years, especially companies that are not at the top their respective merchandise classes. Fundamental data shows Dick’s Sporting Goods Stores on average report the revenue per store, per year at ten million dollars. Sports Authority could only muster sales of five million, per store, per year.
Overseas, the rating agency Moody’s reduced the credit rating outlook on the nation of China to negative; while the ECB is hinting that more bonds will be sold in Europe at negative interest rates. The next Federal Reserve meeting is two weeks away. U.S. Markets ended slightly up in mixed trading. Stay tuned.