361 Capital Weekly Research Briefing

361 Capital portfolio manager, Blaine Rollins, CFA, previously manager of the Janus Fund, writes a weekly update looking back on major moves, macro-trends and economic data points. The 361 Capital Weekly Research Briefing summarizes the latest market news along with some interesting facts and a touch of humor. 361 Capital is a provider of alternative investment mutual funds, separate accounts, and limited partnerships to institutions, financial intermediaries, and high-net-worth investors.

361 Capital Weekly Research Briefing

March 31, 2014

Timely perspectives from the 361 Capital research & portfolio management team

Written by Blaine Rollins, CFA


Sometimes the best option is to stay on the island until the traffic flow becomes clear…


Some further signs of excess appeared last week that will force investors to stop and double check their portfolio weightings…

I remember back in 1992, an IPO hit my desk for a company called Swing-n-Slide. The company sold a bag/box of bolts, brackets, rope and plastic parts that you would buy at the hardware store along with the lumber to build your kids a play set for the yard. Not many barriers to entry and the company had increasing customer concentration with the mad growth of Home Depot and Lowe’s. It went public at the end of summer in 1992 and a year later when sales peaked, the stock also peaked. A few years later the company disappeared from the investing universe and the company was eventually bought up by a private investor. Nuts, bolts, plastic, rope and directions to hang yourself if you bought the stock on the IPO.

Swing-n-Slide went public in 1992 because it could. The Nasdaq had just ripped nearly 100% off the 1990 low and plenty of companies were tapping the market. There were some great growth stocks that went public like Starbucks, Whole Foods, AOL & Express Scripts, and there were the non-growth duds like Swing-n-Slide. It is important to note that the duds that did go public in 1992 did not tank the market. 1992 was bumpy for investors, but the Nasdaq was on a bull market mission to 5,000 by the year 2000. However when higher risk companies get public, you have to keep your antennae up.

Now about Candy Crush. $KING went public this week at a $7 billion valuation. I read that it is making $5 million a day on its current big game which represents 3/4 of its revenues and likely much more of its profits. So at 100% net profit margin, it will pay back in 3.8 years. I am sure the team at King Digital is exceptional as they have done an incredible job of capturing everyone’s free time in the last 12 months. But remember that this is a hit driven business that is distributed through others and this development team just got paid BIGTIME. Do you think that they are still chained to their desks creating that next monopolizing game? Zynga couldn’t do it past Farmville and its stock now trades at $4. Electronic Arts had the sports games locked up and has even grown its sales 30% over 10 years ago, but its stock trades at the same price as in 2003. $KING must repeat with several other addicting games on a growing number of platforms. Meanwhile, there are thousands of very bright people working on gaming… including one at Facebook who last week spent $2 billion to enter the virtual reality gaming space in a MAJOR way.

So maybe Candy Crush and Oculus Rift were the final setups to send momentum stocks into their own ‘Swing-n-Slide’ market. Biotech had already backpedaled due to the hyperbolic move and the pricing challenge by Congress. Then Janet Yellen threw a chip at Value investors last week with her “6 months” comment. Investors know that the next round of economic data points will be strong without the cold weather impact. And then there is that continued increase in bank borrowings. The market was set up for a rotation from growth to value. If you were positioned rightly in March, go thank one of those pieces of fruit on the NYSE floor.


@abnormalreturns: Maybe the core Facebook dot com biz was to give Zuck the grubstake to be some kind of mad venture capitalist on a mega scale.

Speaking of Facebook, here are VC Fred Wilson’s thoughts on Oculus and the hunt for the next big platform…

…the roadmap has been clear for the past seven years (maybe longer). The next thing was mobile. Mobile is now the last thing. And all of these big tech companies are looking for the next thing to make sure they don’t miss it. And they will pay real money (to you and me) for a call option on the next thing.

It isn’t clear if the next thing is virtual reality, the internet of things, drones, machine learning, or something else. Larry doesn’t know. Zuck doesn’t know. I don’t know. But the race is on to figure it out. Trillions of dollars of collective market capitalizations are on the line. So a couple billion here or there is chump change. Except for the people who collect that chump change for selling them an option on the next thing. It’s real money to us.

So for the next few years (I have no idea how long this search for what’s next will go on), a game to be playing is building a platform that can plausibly be the next big thing. It’s a risky game. But the payoff can be large.


By the time that you get this Briefing, the Q1 will be history…

The first quarter comes to an end Monday, with the S&P 500 pretty much having gone nowhere. We’re up all of 0.5% for the quarter. The rotation out of high-beta, high-flying sectors such as biotech, and momentum names (several of which are in the tech sector), continues. In the month of March, the Nasdaq has fallen 3.5%, far worse than the SPX, which is virtually flat (-0.1%) for the month. The iShares Nasdaq Biotechnology ETF (IBB) has tumbled 13.3%. Some of the fallen momentum angels include the likes of Tesla (TSLA), down 13.3% thus far in March, Twitter (TWTR), down 13.5% and Netflix (NFLX), down a fraction below 20% this month.


Some interesting moves for the last week of a quarter. No way that it was all window dressing. Investors are rotating their portfolios into more cyclical and lower P/E names. But I bet there will still be some good short term reversion to the mean trades in the 4 letter momentum stocks starting Tuesday…

Ed Yardeni added some charts to the Biotech conversation last week…


And here are some good graphs showing the shift from Growth to Value from the team at Horan Capital…


As the chart above shows, Bank stocks are a VERY big weight in the Value index. And as ISI Group shows us, bank lending continues to move higher. Don’t forget that Loan Yields are MUCH, MUCH better than Investment Security Yields…

(ISI Group)

The Ukraine is still a topic for global investors, but when you see Soldiers posing for pictures, the situation seems less risky…

(Yannis Behrakis)

President Putin called President Obama on Friday night to accelerate diplomatic talks. No evidence if economic sanctions or Netflix sanctions were the catalyst…

WASHINGTON (The Borowitz Report)—In what was described as a major ramping up of sanctions, Secretary of State John Kerry announced on Tuesday that the United States had frozen Russian President Vladimir Putin’s Netflix account, effective immediately.

“Unless and until Mr. Putin calls off the annexation of Crimea, no more ‘House of Cards’ or ‘Orange Is the New Black’ for him,” Mr. Kerry said. “The United States will not stand by and reward the annexation of another sovereign nation with a policy of streaming as usual.” While all of the sanctions Mr. Kerry announced on Tuesday were Netflix-related, he warned Mr. Putin that “nothing is off the table.”

“I’m sure I don’t need to remind the Russian President that ‘Game of Thrones’ is about to come back for another season,” he said. “As I have said, this thing could get very ugly, very fast.”


A good long read in Barron’s this weekend highlighted again the Russian dependence on energy…

Oil-and-gas revenues account for 70% of Russia’s total exports and more than half the income of its federal government. Russia exports more than seven million barrels of oil a day, second only to Saudi Arabia. One key difference between Russia and the No. 1 exporter is that more than 60% of Russian oil is produced in Siberia, where costs are much higher. A fall in the world price to $75 from $100 would therefore have a much greater impact on the net revenues that Russia earns from oil than is earned by the Saudis.

The downside of the resource curse could also be felt in Russia’s reliance on sales of natural gas. About 75% of Russia’s natural gas exports go to Western Europe, providing 30% of its requirements, at prices that are two and three times the price in the U.S. That enormous premium stems from the fact that there is no world market for natural gas, given the prohibitive cost of shipping it in its unaltered state. Hence, the argument for accelerated approval of liquefied-natural-gas export terminals. With abundant natural gas now available in so much of the world — including Australia, South Africa, Brazil, and Argentina — within the next five years, something resembling a global market in liquefied natural gas will likely develop. That would break the local monopoly of the Russians in their market, enabling Europeans to buy from other sources, and weighing on the premium Russian gas now commands.


Fracking in Germany?

As the planet looks to reduce its dependence on Russia for energy, the global oil service companies stand to benefit from the pickup in activity.


The Oil Service majors are looking to take out their 2011 highs. 2008 next?

One of the biggest surprise moves last week was the big bounce in Emerging Market equities…

…but given how underweight global managers are in EM, it didn’t take much buying to cause the launch.

In the recent Merrill Lynch Survey for the month of March, fund managers reported largest underweight position on Emerging Market equities since inception. Managers are currently underweight this equity region by -31%, which is almost 3 standard deviations away from a decade long average. That is quite a bearish sentiment reading right there! As readers can see from the chart above, fund managers were overweight GEM equities by +43% in February 2013 but nervously switched this position quite rapidly over the last year.


3 months ago, who would have thought that Bonds would blister Stocks for the Q1?


Another sign of risk appetite in the Q1 is the ongoing performance of Spanish (and all peripheral Western European bonds)…

@ReutersJamie: Incredible! Even after 6 quarters of decline, Spanish 10y yield plunges 90 bps in Q1, biggest fall since Q4 1996:

For Small Cap U.S. Stocks, will they get to a record setting 7 quarters in a row?

@ivanhoff: After 6 positive quarters in a row, small caps are finally painting are red one.

Away from the financial markets, we found John Galt living in Colorado, of course…


For the NCAA tournament fans, this video begs the question; would Arizona and Dayton have made the Final Four if they shot their free throws underhand?

THE CHARITY STRIPE 03/25/14 – Rick Barry and the free throw style that made him a basketball legend.



And for the basketball coaches and players out there, here are the numbers on what you may have already read in Malcolm Gladwell’s David v. Goliath…

Yes, this pretty much means a steal is “worth” as much as nine points. To put it more precisely: A marginal steal is weighted nine times more heavily when predicting a player’s impact than a marginal point. For example, a player who averages 16 points and two steals per game is predicted (assuming all else is equal) to have a similar impact on his team’s success as one who averages 25 points but only one steal. If these players were on different teams and were both injured at the same time, we would expect their teams to have similar decreases in performance (on average). Steals have considerable intrinsic value. Not only do they kill an opponent’s possession, but a team’s ensuing possession — the one that started with the steal — often leads to fast-break scoring opportunities.


For those looking for the best ROI on a college degree, Payscale is out with their lists…

Happy to see Colorado School of Mines make the top of the public school list. Call Nick if you have questions about the school for your High Schooler.


Granted we might only be a group of industrious geeks, but what is the public Texas school system trying to teach their young minds?

This was sent in by a reader in Houston who’s 3rd grader missed a perfect score because of the below question. Our recommendation would be for your 3rd grader to drop this course immediately and replace it with a computer programming class.

Why Computer Science Should Be a High School Graduation Requirement…

Unfortunately, according to code.org, 9 out of 10 schools don’t even offer computer programming classes. Even worse, in schools where those courses are offered (usually schools lucky enough to have the funding to teach AP Computer Science), in 31 of 50 states, computer science courses can’t count toward high school graduation math or science requirements. In reality, computer science courses teach logic and critical thinking skills just as well as, if not better than, required math and science courses. Furthermore, computer science education is probably more important over a student’s lifetime than many of these natural science or mathematics courses. Simply put, think about the last time you used what you learned in your high school chemistry, trigonometry, or physics class, and then think about when you last used a computer. Oh wait, you’re using a computer right now! The usefulness of computer science courses should be obvious.


Finally, if you have geek DNA or have a live one running around the house, get this book. We all just ripped through it and would highly recommend it. The language isn’t worse than anything in Apollo 13 or The Right Stuff so also perfect gift for any high schooler interested in math and science.


In the event that you missed a past Research Briefing, here is the archive…

361 Capital Research Briefing Archive

The information presented here is for informational purposes only, and this document is not to be construed as an offer to sell, or the solicitation of an offer to buy, securities. Some investments are not suitable for all investors, and there can be no assurance that any investment strategy will be successful. The hyperlinks included in this message provide direct access to other Internet resources, including Web sites. While we believe this information to be from reliable sources, 361 Capital is not responsible for the accuracy or content of information contained in these sites. Although we make every effort to ensure these links are accurate, up to date and relevant, we cannot take responsibility for pages maintained by external providers. The views expressed by these external providers on their own Web pages or on external sites they link to are not necessarily those of 361 Capital.

Blaine Rollins, CFA, is managing director, senior portfolio manager and a member of the Investment Committee at 361 Capital. He is responsible for manager due-diligence, investment research, portfolio construction, hedging and trading strategies. Previously Mr. Rollins served as Executive Vice President at Janus Capital Corporation and portfolio manager of the Janus Fund, Janus Balanced Fund, Janus Equity Income Fund, Janus Aspen Growth Portfolio, Janus Advisor Large Cap Growth Fund, and the Janus Triton Fund. A frequent industry speaker, Mr. Rollins earned a Bachelor’s degree in Finance from the University of Colorado, and he is a Chartered Financial Analyst.

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