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Comments on activity in client accounts

28 April 2017

For the first quarter the S&P 500 was up 6% while our accounts were flat to down 5%. Below we discuss recent activity in accounts to give an idea of our thinking process. as always our weekly posts on activity in accounts is available at http://www.lemleyletter.com

Our concentration in domestic oil has not been profitable this year but the same could be said last year at this time. Eventually oil prices recovered and we did well with them for the year. This year we own oil as a hedge against missteps by the Trump folks. We also believe that with oil remaining near $50 that the companies have adjusted expenditure to the new reality and that losses will turn to profits with time. And with their revamped financial positions the companies are well suited to take advantage of any untoward world incident oil spikes.

Retailers are a different animal. We bought a package of department stores and a package of specialty retailers. That approach has not worked as the financial press seems intent on burying all retail except Amazon. We sold all our department stores with mixed but not disastrous (except for our February misguided adventure in Macy's) results. We also reduced our specialty companies to Urban Outfitters, Ascena and Abercrombie. Gap profit offset our loss in American Eagle.

Abercrombie is still trying to figure out how to reach consumers and while in former days we would have taken a much large position we are treading more carefully in our dotage. Ascena is in the process of integrating the huge purchase of Ann Taylor. The family who runs the company were born in retail and since ASNA now covers the gamut of women's clothes with Justice and Ann and Lane Bryant we are willing to give them time. Finally Urban has been run by Richard Hanes and his wife forever and its stores have always been stand alones-not in malls- with the Urban Outfitters stores located in college towns- its main client base.

We have been trading profitably in and out of Sprouts Food Markets. We sold SFM a couple of weeks ago at a profit. Last week rumors spread that it was being shopped and the shares jumped 10% and then settled back down to our sale price. This week rumors spread that Whole Foods was being sought by Albertson's and Whole Foods jumped 10%. Consolidation has been continuing in the food store business for the last decade. Our thought has been that Whole Foods should buy Sprouts which is the kind of store that Whole Foods is building with their 365 store concept. Whole Foods could acquire over 200 stores at a much cheaper price than building out the same number of stores. And Whole Foods has the experience of doing this activity from their acquisition of Wild Oats many years ago.

We have chosen to concentrate on The Domestic Oil producer ETF and Marathon Oil for our petroleum positions while trading Devon and Apache.

We added GE this week because CEO Immelt needs to get the share price moving or be out of a job.

In the what were we thinking department- We bought U.S. Steel for a trade after it dropped 25% on Wednesday the 26th. We sold it Thursday morning after a sleepless night caused by X failing to hold its slight intraday recovery high in the last hour of trading Wednesday. Shares opened lower on Thursday and we sold at a too large but manageable loss. We realized (reluctantly) that we don't need the drama of the shorts versus longs at this all-time high in the markets. Bad trades like this are painful but also reminders that hope is not an element of a successful trading strategy.

We trade out of Novo Nordisk and Deutsch Bank when they popped on the French election results. We are willing to revisit lower. And we also eliminated Bristol Myers and Under Armour when they popped on earnings and allowed us to get out with a scratch profit after being underwater since we purchased them. UA had a better than loss and BMY a better than profit. UA's shoe sales were flat and since that is the driver of this stock we are out looking in. We have a natural aversion to drug stocks because of the way they rip off sick folks and this may explain our inability to make any real money in them or hold them for very long.

We own 3D as a robotics play and First Solar as a cheap cheap solar play. FSLR is priced at $28 and has $18 net cash in the company that they use to finance construction projects. We know the old metrics don't mean much to the big boys and girls and gurus (see Amazon and Tesla) but we view the FSLR cash as an enticement for a company like GE to buy FSLR to expand its solar portfolio.

Ford is our ‘old stockbroker' investment (5% yield, 8 times earnings, $20 billion net cash and other boring metrics). Amazon is priced at $450 billion and just reported a quarter where revenue approached $36 billion and net earnings were almost $750 million. Funny thing is that Ford's quarterly numbers were $39 billion revenues and $1.6 billion profit (2X AMZN) in a bad quarter for Ford. Ford is valued by the markets at $45 billion


We continue to think of Spring 2000 little earnings stocks like Facebook and Amazon and Bidu and Netflix and no earnings stocks like Tesla leading the way. But with a tax cut likely to pass (since even Dems will vote for it- everyone loves a tax cut), our guess- not an educated one-is that the rally will reignite before eventually playing out. But with the sell in May date approaching ---

ETFs are the new bugaboo since even institutional investors along with individuals are buying them and the big boys and girls are arbitraging ETFs eight ways to Sunday with options and futures and underlying stocks. When the correction comes and everyone heads to the door the crowd is going to create some panic. Hopefully we are through the door before that occurs.


Eddie Einhorn — a hedge fund manager is very astute- because he agrees with us ☺ -

It was a difficult quarter to be short the bubble basket, and TSLA in particular. Perhaps as the prospects for tax reform have dimmed, the market has regained enthusiasm for profitless companies that aren't at risk of paying taxes. A number of these stocks are back in full-blown momentum mode. Analysts continue to raise "target prices" which the market treats as news. The bulls explain that traditional valuation metrics no longer apply to certain stocks. The longs are confident that everyone else who holds these stocks understands the dynamic and won't sell either.

We have discussed this phenomenon before. It is dreams that Elon Musk sells, not cars. Tesla can't be understood through rational pricing metrics, but semi-divine revelation. For a mathy guy like Einhorn, this kind of faith-based valuation is perplexing.

Anyway, this is all coming to a bad end, Einhorn assures us:

With holders reluctant to sell, the stocks can only go up – seemingly to infinity and beyond. We have seen this before. It's painful for the shorts, as the TSLA CEO has been happy to remind everyone via Twitter. There was no catalyst that we know of that burst the dot-com bubble in March 2000, and we don't have a particular catalyst in mind here. That said, the top will be the top, and it's hard to predict when it will happen. Notably, a number of bubble stocks advanced despite missed expectations and/or falling estimates. The basket is sized appropriately with the understanding that twice a silly price isn't twice as silly. In due time, we expect these bubbles to pop.


This news item was missed in this week in general hullabaloo of the Rump era. More spending requires higher oil prices.

Saudi Arabia's King Salman restored bonuses and allowances for state employees, scaling back an austerity program that generated criticism among citizens accustomed to generous state handouts.

reads whole article: https://www.bloomberg.com/politics/articles/2017-04-22/saudi-king-restores-state-employee-bonuses-as-overhaul-broadens

To whom will they sell?

The intriguing double-play combination of Derek Jeter and Jeb Bush took a major step Tuesday toward taking the reins of the Miami Marlins.

A group headlined by the future Hall of Fame shortstop and former Florida Governor have reached an agreement in principle to buy the team from Jeffrey Loria, according to a source with knowledge of the situation.

The deal is pending approval from Major League Baseball and finalization of other details, which could take months to complete.

The agreed upon price is $1.3 billion, according to the Miami Herald, which also reports that Bush plans to be the Marlins' "control person" among a group that includes at least five investors….

Loria and his Canadian investors purchased the team from John Henry for $158.5 million, while Henry gained approval to buy the Boston Red Sox for $700 million and MLB took over operation of the Expos, who were later moved to Washington and became the Nationals.



Corporate America prides itself on rewarding success and punishing failure. Yahoo CEO Marissa Mayer does not fit comfortably into that narrative. During her five-year tenure at the once-proud tech firm, user levels stagnated, ad revenue dropped, acquisitions cratered, layoffs accelerated, product quality floundered, and hackers stole the personal information of more than one billion users.

But when Yahoo's sale to Verizon becomes official in June, with the restructured company renamed Oath, Mayer will walk away with $186 million, according to a regulatory filing released this week. That includes shares of Yahoo stock Mayer owned, stock options, and a $23 million "golden parachute" of cash, restricted stock units, and medical benefits. Mayer did relinquish $14 million while taking responsibility for the Yahoo Mail data breach, but she'll get 13 times that amount just to no longer remain part of the company.

Under current practices, CEOs have a deep financial interest in merging their companies.

Mayer's award is not merely an indictment of short-term thinking in executive boardrooms, which prioritizes increasing stock prices (the one thing Yahoo achieved) over creating a decent company. It reflects a real problem with executive compensation, which favors the very kind of corporate consolidation that is distorting our economy. Under current practices, CEOs have a deep financial interest in merging their companies. Their spectacular bonuses serve as a kickback for concentrating power in fewer and fewer hands.


No Easy Answer to Drone Defense

The manual says the prevalence of drones costing $650 or less has led to a paradigm shift that has forced the Army and military to think differently about how it operates in the field.

The drones are typically too small for traditional air-defense units to catch. It advises unit commanders to assume a small drone is an enemy reconnaissance asset or worse.

"Small units operating in and around combat areas should assume they are being observed by the enemy and not assume they are under the umbrella (protection) of air and missile defense units," the manual reads. "If a unit is deployed tactically in the field and encounters UAS threats of any category it must be assumed that the intentions of the UAS are hostile, regardless of its actions."


Here's Why Trump Is Having a Cow over Canadian Milk

US agriculture programs give dairy farmers incentive to produce as much as possible, embroiling them in boom-and-bust cycles like the current one, driving small farms out of business and forcing survivors to scale up. As recently as 1950, around 3.5 million US farms kept dairy cows; by 2012, that number had dwindled to 58,000, even as overall production surged. The shakeout continues. "In 2010, Vermont had more than 1,000 dairy farms, but by the end of last year there were just more than 800," NPR recently reported.

…• Canada's dairy farmers are largely insulated from these cycles. That's because, in sharp contrast to the US government, Canada's dairy policy is based on production quotas that prevent farmers from either under- or overproducing. The program guarantees farmers get a price that covers their production costs, and slaps a high tariff on dairy imports, protecting them from foreign competition. Canadian consumers tend to pay more for milk than their peers, but not prohibitively so. Overall, Canadians devote just 9.7 percent of their overall expenditures to groceries, one of the lowest rates in the world. (US consumers have the lowest rate of all: 6.4 percent.)

Canada's dairy program, known as "supply management," might sound crazy to US ears, but it has advantages. In an excellent 2010 Gastronomica article, Barry Estabrook noted that, while decades of booms and busts had hollowed out dairy farming in New England and upstate New York, small and mid-sized dairy farms just over the border in Ontario—farming the "same gently rolling tapestry of field and forest"—are thriving.



21 April 2017

With the naval armada steaming somewhere and North Korea and Trump trading insults we decided to lighten up. Hopefully nothing comes of the continuing insult trading but we aren't comfortable with the seeming gridlock in Washington as the Trump administration gets its feet wet. The Trump rally was based on the premise that with Republicans in control tax cuts, infrastructure spending and cheaper better health care would quickly emerge. Not yet :-)

To replenish cash we looked to our large retail positions and sold the big box retailers except Target which we think has the most certain chance of price recovery and also sold half our specialty retailers reducing positions to Urban, Ascena and Abercrombie. We did use some of the cash raised to add to Urban in many accounts.

We sold QUALCOMM ahead of earnings. Three analysts had downgraded the shares in the days before the report and QCOM's dispute with Apple will be a continuing negative. With the proceeds of the sale we bought an equal number of shares of Marathon Oil. We are sticking with our Oil overweight in XOP and MRO.

Finally we switched Stratasys to 3D in robotics on a share for share basis realizing a small profit and raising a bit of cash at the same time.

As of Friday we own:

XOP, Marathon Oil, Verizon, Novo Nordisk, Bristol Myers, Ford, 3D, Deutsch Bank, First Solar, Under Armour and in retail stores: Target, Urban Outfitters, Abercrombie and Ascena (Ann Taylor, Justice and Lane Bryant).

With the new administration getting their feet wet we remain less certain of markets - thus our caution. We have no idea where political/world events are heading but the fumbling on Health Care, Tax reform and infrastructure spending is not confidence inspiring.

As always time will sort events- hopefully happily.


Passover/Easter 2017

While we were away the markets meandered and our accounts recovered a bit as retail stocks gained as did oil producers. We are flat to down a bit for the year while the markets are about 4% higher. Retailers rise and fall on a daily basis as talk of a border tax ebbs and flows. Our thought is that it won't. We are in the process of getting our feet wet again after a two week hiatus. We added to First Solar and re initiated a position in Verizon in some larger accounts.

The three generals (Mattis, McMaster and Kelly) seem to be in charge at the White House now which is a good thing for national security although a bit more hawkish than we would like:


An ironic commentary On Tesla which jibes with our take on the market value of the company versus Ford and GM.

Telsa Is Giving Analysts a Taste of the Ineffable Mysteries of Existence

By Owen Davis

C.S. Lewis called it the numinous. Ancient Dionysian cultists named it ekstasis. The Buddha achieved nirvana. Today, this timeless experience of leaving one's mortal flesh to feel some trace of the infinite, however fleeting, has found another name: Tesla.

AutoNation CEO Mike Jackson took aim at Tesla on Tuesday, saying the company's market cap surpassing that of General Motors' is "inexplicable."

Jackson seems to be on the path to some form of epiphany here, but he stumbles when he starts splitting hairs about profitability and other trivialities. Compare his spiritual journey to that of Piper Jaffray, whose Tesla note this week turned some heads.

Tesla's products have a captivating impact on consumers and shareholders alike; this advantage will be difficult to replicate.In the minds of its customers, employees, and shareholders, Tesla isn't just another company. More so than any stock we've covered, Tesla engenders optimism, freedom, defiance, and a host of other emotions that, in our view, other companies cannot replicate. […]

We sympathize with bears – but their (arguably rational) arguments probably won't matter. In many ways, TSLA seems to play by its own rules. The company burns through cash at a rate that better-established companies would likely be crucified for — especially considering TSLA's rickety balance sheet and penchant for raising equity. Tesla's production timelines are unreasonably fast, at least based on "expert" opinions in the automotive industry, and the company spurns various industry norms. For instance Tesla has avoided LiDAR in its self-driving systems (which some claim is dangerous), while pursuing a direct sales model that dealerships fiercely oppose. Yet, because of its superior products, loyal shareholders, and inspiring mission, TSLA remains unscathed.

The key word there is "inspiring" (etymology: the intercession of the divine, the literal breath of God). To really understand the cult of Tesla, one must abandon earthly measures like enterprise value and EBITDA and instead put one's mind on autopilot and repeat mantra-like the proclamations of Elon Musk. Become the car that drives itself. Grapple with the singularity. Dream the dream. As Musk has said: "Your faith will be rewarded."

As with any transcendent experience, however, the whole Tesla thing can appear to the uninitiated like a bit of a scam:

The head of the nation's largest auto retailer even joked that Tesla was "either one of the great Ponzi schemes of all time or it's gonna work out." […]

"What would impress me about Tesla?" Jackson said, speaking at the NADA/J.D. Power Automotive Forum ahead of the New York Auto Show. "Selling vehicles at a profit would be very impressive. Giving away vehicles at below what it costs you to make them is not very exciting."

These arguments might move a confirmed skeptic, but not a true disciple. Contra St. Thomas Aquinas, it's not possible to prove the truth of Tesla's gospel with reason alone. Instead, it requires a Kantian act of faith, a leap beyond what we mere humans can grasp with our crude senses, an exercise of the heart and not the mind. It also requires about $309 a share.




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