Exploit the Noise

 | Feb 11, 2013 | 4:30 PM EST  | Comments
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abr

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One of the hardest things to do as a long-term value investor is avoid the constant noise from the markets. There has been an excess of noise around Chez Melvin these past few weeks, and at times I find myself tempted to give into the macro weirdness and retreat to a cabin in the woods. The noise level is at its highest levels among traders and investors who have been around for a few decades and are struggling with the changes over that time frame. It seems the shorter the time frame, the worse the noise. Unfortunately, I have a lot of friends who trade short-term instruments and have unrestricted access to telephones.

If you listen to the noise, you really can get scared at times. Sentiment measures are off-the-chart bullish right now, according to some of my associates who track such things. The public seems to be pouring back into the markets via equity mutual fund according to the mutual fund flows. The so called dumb money love stocks and historically that has been a horrible sign for short to intermediate-term market direction.

Europe is still a mess. The Fed keeps printing and that is going to cause either runaway inflation or severe depression. Hedge fund buying has created a mini bubble in residential real estate prices. Jobs growth is still very weak. GDP is not growing very fast. The Chinese year of the snake is not good for stocks. Congress is a mess and getting worse. Oil prices are edging up again. The Market Volatility Index (VIX) is too low. All of these factors are more or less true, but they have nothing to do with the key question for a long-term, asset-based value investor. Is the company cheap and can it survive?

I confess to certain amount of concern because the output form my value screens is pretty low right now, and that has normally indicated that the market may be due for a pullback. There is simply not a lot of new safe and cheap inventory being created right now. I have to remind myself that while this may indicate the need for a market pullback it says nothing about when or how much higher we may go before one occurs.

When I find myself feeling the pressure of the noise, be it bullish or bearish in tone, I like to sit down with my portfolios and ask  simple questions. It helps gain some perspective. The world may or may not be collapsing around us, but does that mean I want to sell a stock like Kelly Services (KELYA)? The stock has had a great run and the shares have risen almost 40% in the past month. However, I see that the stock is still trading at a slight discount to tangible book value and business conditions are improving. I might not be a buyer at the current price, but I am certainly not a seller at this price.

I have a lot of commercial real-estate-related securities in my portfolio. All of them have done very well over the past two years, as markets have slowly improved. But when I check, I see that none of my hotel REITs trade at a large premium to their book value, and all of them are seeing improving operating conditions. They all pay healthy dividends. The CRE financing REITs such as Arbor (ABR) and Northstar (NRF) have done very well, but they are also still fairly cheap.

When I did this exercise, I found a few stocks, Granite Construction (GVA) for example, that have staged huge runs and were no longer cheap. There are a couple of pending takeovers, including Energy Solutions (ES), that needed to be sold. There was still a little bit of Sprint (S) left in one of my more aggressive accounts that likes longshots. I went ahead and sold that last tiny bit of Disney (DIS) I had been holding on to for seemingly forever. Most of what I own is still cheap, so I will just ride out any bumps that may happen in the near term.

I have been doing this stock thing for a few years now and I have a great deal of confidence in the value-oriented approach. There will be lots of market gyrations and noise but if I focus on buying stocks when they are super cheap and entirely unloved, the movements work for me instead of against me. A philosophy of buying safe, cheap issues during the short- and intermediate-term downturns should help smooth the ride to profits.

There will always be noise forming pockets of fear and greed. Rather than embrace them, exploit them for your benefit. Focus of really important things -- like the fact that pitchers and catchers report today.

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