Saturday, June 10, 2006

The Sell-Off

“Face up to two unpleasant facts: the future is never clear and you pay a very high price in the stock market for a cheery consensus. Uncertainty is the friend of the buyer of long-term values.”
Warren Buffet, Forbes, August 1979

It has been a fun ride over the past 4 or 5 weeks. The Dow, Nasdaq and S&P 500 have corrected by about 7%, 10% and 6% respectively. Ouch. The volatility stems from the market’s uncertainty over the Fed’s interest rate policy and whether or not Mr. Bernanke will follow through with the Fed’s 17th consecutive rate hike in late June. Inflation appears to have pierced Mr. Bernanke’s 1%-2% comfort zone, albeit fractionally, and that has made investors jittery. Add to that the carnage in emerging markets in recent weeks and you have yourself a real doozy of a situation.

What to do? Does it make sense to sell, sell, sell a la Jim Cramer or should you instead be taking advantage of the sell-off to add to your positions. By now you should know what my answer will be. To be fair, my brother and I have trimmed or eliminated some positions in recent weeks. In particular we liquidated our Goldcorp (TSX: G.TO) position, took some money off the table on Chaparral (Nasdaq: CHAP), and reduced our position in Vimpelcom (NYSE: VIP) by 50%. Otherwise, we have used the decline to add to some of our core holdings. We have added to Ebay (Nasdaq: EBAY), Intel (Nasdaq: INTC) and Microsoft (Nasdaq: MSFT). We also nibbled a bit more at Centex (NYSE: CTX) and may do the same with Pulte (NYSE: PHM).

The homebuilders have been beaten up badly as they continue to reduce their earnings forecasts and worries about further interest rate hikes weighs on their shares. But my thesis remains intact. Scarcity of land and demographics are still positive long-term trends that should benefit the larger players. Further pain in the sector will also provide them with the opportunity to drive consolidation through the sector by gobbling up weaker players. Meanwhile, Bill Miller continued to build his positions in these companies through Q1. When we initiated our position in the homebuilders, I told my brother there could be a 20% downside in the shares. That scenario sure has materialized. To add fuel to the fire, a slightly worrisome article in a recent issue of Barron’s questioned the nature of off-balance sheet JV’s set up by various homebuilders to boost ROA and ROIC. The article also questioned whether the companies can truly walk away from the options they have purchased to buy land. Various CEO’s have claimed the use of these options will reduce their financial exposure during a downturn. In any event, I continue to believe in the soft landing scenario for housing. These companies have been around for decades and they are certain to provide us with a reasonable rate of return in the long run.

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