Hedging is making an investment to reduce the adverse price movements of an asset. Normally, a hedge consists of taking an offsetting position in a related security, such as a futures contract. The reason I mention hedging is because it is a way to lock in prices in a situations where a price moves against you which can cause major losses. In the capital markets, risk management encompasses the use of hedging in a big way. For example, a few years ago we had a stock position in a company based in South Africa where the currency is the rand. The company had all of its revenues and the majority of its costs based in rands, which were then converted to dollars. As such, there is a great deal of exposure to the fluctuation of the rand versus the dollar. The company was and continues to grow quickly, and it has expanded is operations outside of South Africa. At the time, the company did not hedge its rand exposure by selling forward contracts in the currency markets. As an investor, when the rand lost 25 percent of its value versus the dollar a few years ago, naturally it provided a huge headwind for those equity owners. Fortunately, we were out of the position long before that, lucky us. Why is this pertinent for the current environment? Yes, we are a one trick pony, at least right now, and the answer dear friends, lies in the recurring theme, at least of this author's blog, of oil.
You see, the art of hedging is certainly applicable in nearly every industry on the planet, but especially in one where the underlying asset is volatile, which would be, voila, oil. So, the oil producers which live and die on the price of oil, or at least one would think that on the surface, actually can kind of cover their you know what by hedging. In fact, in many cases, the price of oil for the large companies is hedged to make sure they lock in high prices when they can, for as long a time period as possible. In the case of large integrated oil companies, they have active trading departments whose sole specialty is to make profits by buying and selling oil in the commodity futures market. I can recall a few years ago one of the major oil companies made more money in their trading of oil than they did from producing and refining it. In listening to a large producer this week talk about their business, 85% of their production price for the next few years was locked in at $100 per barrel or more. Yes, the oil guys are generally from the south and they have a drawl, but they did not fall off a turnip truck either. Many of these companies are worth billions of dollars, and you don't build that much value by not thinking through the ramifications of different adverse circumstances. So, for many of the oil guys, heads we win, tails we win. Nice work if you can get it, eh?
Yesterday, the U.S. labor department released the November jobs report which showed non-farm payrolls jumped by 321,000. The number was a big shock as it beat estimates by 90,000 and was the largest gain in employment in nearly three years. Naturally, the politicians, including our always humble and modest leader, eagerly crowed about such a wonderful achievement. Interesting that the private sector is the area where the job growth was strongest, providing 314,000 out of 321,000 jobs, or 97.8% of all job creation in the country. Yet our current head honcho has long trumpeted his idea that government should be a larger force for employment. In spite of being completely wrong about how most new employment positions are created, our elected 'representatives' have the gall to stand up in front of the television cameras and prance about as if they were responsible for all which is good in the world, which naturally, includes the ever increasing stock market.
The lovely beast known as the equity market continues to rise as the end of the year rapidly approaches. The same themes we have talked about for a while have generally held up well, those being anything tied to the consumer and non oil related. The oil patch, while stabilizing a bit, is still probably the victim of risk managers from large institutions who want clean books going into the end of the year, and might see the next three weeks as an opportunity to shed their losers. Also, tax loss selling certainly will be a factor for these issues as well. I would expect the more of the same as we bid 2014 goodbye, and begin anticipating the new Annam.
Finally, it has come to light the phenomenon known as Uber, the taxi payment service, received a private placement valuing the entity, at, make sure not to blink twice now, $41 billion. Forty One Billion. Yup. A taxi service worth forty one billion, huh? It, along with its brethren, AirBNB, Box, and Dropbox, are all waiting in line in Silicon Valley to take advantage of favorable public market conditions. The lead story in Barron's this week highlights the difference between the tech sector today and back in 2000 when they predicted the dot com crash. Companies are waiting a lot longer to become public and they are much larger and more profitable when they greet public investors. The valuations they command from the venture capital community and late stage investors is far greater as well. Large institutions like Fidelity and T. Rowe Price have begun investing in these companies before they even come public as a way to participate and take their risk off the table. Heads we win, tails we win.
Disclaimer: Y H & C Investments, Yale Bock, and the family of Yale Bock own positions in securities mentioned in the blog post. Investing in stocks can lead to the complete loss of your capital. As always, on any company mentioned here, past performance is not a guarantee of future returns. Investing involves risk of losses on invested capital. One should research any investment and make sure it is suitable with your objectives, risk tolerance, risk profile liquidity considerations, tax situation, and anything else pertinent to your financial situation. Also, the CFA credential in no way implies investment returns will be superior for any charter holder.