Wednesday, June 6, 2012

June Investor Letter

Below is a letter that is written monthly for the benefit of Avondale Asset Management's clients.  It is reproduced here for informational purposes for the readers of this blog.

Dear Investors,

The dichotomy of sentiment surrounding capital markets this year has certainly been something to be marveled at. Markets rocketed higher in January, February and March only to come crashing back down in April and especially May. The first quarter of 2012 was the 8th best in 50 years, but the second quarter is on pace to be the 5th worst. Once up 15% for the year, the S&P 500 is now only up 4% and the Dow has fallen into negative territory.

I’m happy to say that although we were a little early in positioning ourselves for this correction, we did hold our ground as the market rose in March and thus were well positioned for the substantial decline that we saw in May. While our holdings declined in market value along with everything else, we lost less than the market did, which is a huge positive. It’s never fun to look at our accounts and find them marked lower than they were at certain points during the year, but the substantial cash position that we have held allows us to reinvest at much lower prices and take advantage of declines. We started to buy heavily in late May and will continue to make purchases as the market presents opportunity. As a result of the decline there is plenty of opportunity.

In February and March I wrote that it was difficult to find stocks that looked attractive on a long-term basis. That changed in May, and today many of the stocks that I analyze appear to be selling at 30-50% discounts to where I believe they could be valued just 12-18 months from now. Of course, near term market fluctuations are difficult to predict, and so there’s a good chance we may have to wait patiently for these gains to materialize. But at least I feel confident that the prices we are paying today for our companies are favorable to us on a multi year horizon.

Even though I’m very happy with how we did in May, we certainly weren’t without fault. In particular, I don’t feel that I sold enough of some holdings as markets hit year to date highs. Additionally, commodity related investments suffered a particularly harsh beating last month. Driven by what I saw as favorable valuation relative to other opportunities, I unfortunately let these investments become too dominant in some portfolios. I learned the hard way that cheap can get cheaper. Now that these assets have already been marked lower though, I don’t think that we need to sell them. By my math, most of these companies are already forecasting a particularly harsh economic scenario that I am not expecting to come to pass.

In terms of economic outlook, all of a sudden I find myself significantly more optimistic than most others in the market even though my outlook hasn’t really changed much at all. So far, the data I’m looking at isn’t indicating that we are experiencing anything other than a typical seasonal slowdown in the context of continued cyclical expansion. If anything, recent declines in commodity prices bode well for future economic activity. Lower oil prices are a meaningful stimulus to the US consumer, and, importantly, open the door for the Chinese to loosen monetary policy for the first time in several years. Still, Europe is a real problem. I have been as vocal as anyone regarding the secular headwind that global sovereign debt poses, but I think in the medium term I believe a sentiment rebound could overcome these concerns. I don’t believe recession is around the corner quite yet.

Scott Krisiloff, CFA

Opinions voiced in the letter should not be viewed as a recommendation of any specific investment.  Past performance is not a guarantee or reliable indicator of future results.  Investing is subject to risk including loss of principal.  Investors should consider the suitability of any investment strategy within the context of their personal portfolio.  For more information on Avondale Asset Management, readers may be directed here.

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