Giddy

As I have mentioned before, control of emotions is important for investment success -- emotions can often make us do irrational things such as buying at the top (greed) and selling at the bottom (fear). Your best gains come from doing the opposite -- trimming when others are greedy and buying when others are fearful. When the markets are running higher, I find myself feeling giddy with excitement -- that's my drug -- no other feeling like making money from the right stock calls.

With the portfolio up over 16% (4.95% better than the S&P 500) this year its an exciting time. I was re-reading what I said at the bottom in August and I would give myself a mixed review. I correctly nailed the bottom with a note published late Thursday night (the 16th of August) prior to the discount rate cut the next morning. But I referred to a short term bottom -- not THE bottom before a huge rally in the market. I wasn't pounding the table and that was wrong.

DFR -- now up to 10.26 -- over a $1 above where I trimmed for risk purposes. I'm not upset about that -- the stock was too much of my portfolio and its daily ups and downs was bothering me -- that's the sign its too big. Once they report Q3 earnings I would expect one of two things will happen:

they will either have no issues with their book value and will declare the same dividend and talk about growing the dividend over time in which case the stock will work its way up to the mid teens OR their book value will take a hit due to credit losses or mortgage pricing issues (leverage) and the stock will stay around 1X book value at most. Right now if I had to bet it would be that the stock makes the mid teens but again -- that comment is made during a moment of giddiness -- probably won't be as good just like it wasn't as bad as I was thinking when I was writing notes wondering if they would survive back in August.

Will need to do some more writing on Illumina soon -- they had an analyst day a month ago and I have just gotten around to doing some reading about it. They talked about offering genetic data on individuals for $1000 in a deal with 23 and me (google founder's wife's start up). That could be interesting. The good news for ILMN is that the desire for genetic research is infinite -- there is no limit to the number of studies that would be conducted if funds were available. That is the limit to their growth -- fund availability. As the cost of sequencing a human genome drops from millions to thousands, volume will soar but in the end there are only so many dollars available unless they can access other pools of money beyond research budgets like consumers (23 and me) and diagnostics. Keep in mind when you look at the published valuations that its not as bad as it looks -- their free cash flow is pretty darn good -- usually well in excess of the earnings numbers people use to value them.

CME -- stock has had a great run -- turns out the day after I last bought some, the B of A analyst put out a report explaining that there was no sign of hedge funds reducing their leverage or use of derivatives. Stock has taken off ever since. Apparently many investors were concerned that investors were deleveraging and that meant fewer derivatives. so far no sign of that. I would keep in mind the huge growth opportunity at the CME is the switch from OTC to exchanges. Over the counter trades in currencies and interest rate swaps are many many times larger than those done on exchanges. OTC provides flexibility in setting terms of derivative but exchanges provide greater liquidity and less counter party risk (risk the other side won't live up to terms of the trade).

Personally I think the industry trend towards greater use of leverage to generate higher returns for clients is a scary one -- leverage comes in multiple forms but in this case I mean new 130/30 funds where a manager goes short their worst names using 30% of the fund's capital and then redeploys that money into their favorite names (i.e. the 130 part) . goal is to earn a higher return, while having the short side maintain same risk profile. It won't work as well as they think -- they are back testing it on periods where there wasn't as much short interest and therefore once you add all this new shorting capacity the markets will change. Other forms of leverage include greater use of derivatives, which are leveraged securities. I am not as worried about a system failure as I am investors dramatically increasing their chances for being wiped out or losing much higher percentages of their wealth than they thought possible. At some point this might be a risk to CME's growth but in the meantime they are a huge beneficiary.

So back to being Giddy -- wouldn't be surprised if we have a pullback soon -- things have run quite a bit here so a rest is in order. still bullish longer term but a rest is ok.