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Kass: Fallen Angels & Lessons Learned

Written by Doug Kass | Sep 5, 2018

“Hello I Mr. Ed.

A horse is a horse, of course, of course,
And no one can talk to a horse of course
That is, of course, unless the horse is the famous Mr. Ed.

Go right to the source and ask the horse
He’ll give you the answer that you’ll endorse.
He’s always on a steady course.
Talk to Mr. Ed.”  – Theme Song to Mr. Ed

The rapid decline in Tesla’s (TSLA) shares over the last month and the continued fall of two prior market darlings, Intel (INTC) and Micron (MU) , should remind us of the poisoned cocktail of “ Group Stink.”

Should the market fall, as I expect, there will be many more fallen angels.

I wanted, therefore, to reposte a recent column, “A Horse Is A Horse Of Course, Of Course” – which “bears” repeating because of the lesson communicated:

Rising stock prices have a way of changing sentiment (h/t Divine Ms M) 

Eleven years ago, as The Great Recession was bubbling up, market commentators were nearly unanimous in the view that the proliferation of those weapons of mass financial destruction (mortgage derivatives) would not produce a contagion.

Those commentators were famously wrong. Indeed, were it not for swift monetary and fiscal relief, the deep contagion that engulfed the global financial system would have bankrupted the entire worldwide banking community and companies like General Motors (GM)  , Bank of America (BAC)  , Citigroup (C)  and many others would no longer exist.

“Contrary to the view of some, a possible change in Washington D.C. leadership and policy may have broad investment ramifications on numerous market sectors (e.g. drug, defense and financial industries)”– Kass Diary, All the President’s Men (and Mess)

Today, though the body of the Administration has been diseased (in multiple ethical, moral lapses and in other ways), many of those same commentators who dismissed the mortgage derivative problem (a decade ago) suggest ignoring the indictments and guilty pleadings of multiple campaign members of the Trump team and the general culture of corruption that currently exists in Washington, D.C. — that these considerations will have little impact on policy, the balance of power, the economy and our markets.

Many of the same “talking heads” also possess the same view that bearish market analysis rationale may sound superior to the bullish case – but, they too, in the main, are wrong. Instead, many of them quickly point to a chart or some other independent variable in support of their (non-rigorous) case.

As Ben Hunt wrote in this week’s Epsilon Theory ( Death in the Afternoon):

“Where there’s shame, for both investing and beekeeping, is not sticking with your process. And if your process is only for getting into an investment or starting a new colony … sorry, but that’s not a process. Investments and animals have a life cycle. Your JOB as an investor and a beekeeper is to be there for the entire life cycle, even for the really hard parts like culling a weak queen or getting out of a weak investment. Even if it’s raining outside.”

I remain an investor (and the author of my Diary) because I have profited over numerous stock market cycles over the last four decades.

I have consistently resisted (when appropriate) the notion of “Group Stink” and the commonly held view by many that superior investment performance can be achieved by a simplistic view or by a quick glance at “activity” or at a chart.

The investment mosaic is complicated.

Back in 1980 I entered the harness racing business – over time I raced, bred and drove trotters and pacers.

My first trainer was Pittsburgh’s Delvin Miller. Delvin was a legendary horseman but he was much more than that, for those were the days when harness racing was a popular sport.

Delvin was the single most accomplished and popular trainer and owner in the world. He was a close friend of three presidents and Arnie Palmer’s closest pal. (And for the first five years of my involvement in the sport, Arnie was one of my three partners).

One word of advice from Delvin that I have held on to over the last 30 years was something that he said to me while we were attending the annual and largest Standardbred auction at the Farm Arena in Harrisburg, Pennsylvania back in the early 1980s:

“Dougie, look carefully at the crowd bidding on the yearlings this morning. There is a reason why, every year, there are the same sellers, but the buyers seem to routinely change every few years.”

Think about Delvin’s pearl of wisdom – it holds investment weight.

Back to Mr. Ed:

“Go right to the source and ask the horse
He’ll give you the answer that you’ll endorse.
He’s always on a steady course.
Talk to Mr. Ed.”


IF….

The investment mosaic is complicated and, at least to this observer, cannot be solved easily through a simplistic and linear process like gazing at a chart or by a casual glance of “unusual activity” – or by utilizing any other one single independent determinant.

Chasing benchmarks and worshipping at the altar of price momentum may be a recipe for occasionally achieving some short term gains but is not, in my view, a recipe for long term (measured in years/decades) investment gains.

To me, a serious investor (not trader) who searches for the holy grail of alpha, must comb through a maze of fundamentals, technicals, valuations, sentiment and other (changing) factors in an objective and calculating way.

***

With the benefit of hindsight, the past 10 years has been skewed by several positive influences which have resulted in an uncommonly resilient Bull Market:

  • The influence of passive investing – ETFs and quant strategies that are virtually agnostic to balance sheets and income statements. Rather, price momentum is their investing altar.
  • The monetary largesse of the central bankers who have inhibited natural price discovery by inundating liquidity into the system and lower interest rates to generation lows.
  • Fiscal policy that has widened the gap between “the haves (with large balance sheets of real estate and stocks) and the have-nots (with stagnating wages and rising costs of living).”
  • Both monetary and fiscal policy which have resulted in aggressive corporate share buybacks which has reduced the float of the outstanding shares of publicly traded companies (by about one fifth) – thus improving and tipping over the demand v. supply equation.

Each cycle brings new variables and challenges.

Value is subjective and its definition is liable to change. (see Valeant Pharmaceuticals and more recently the decline in the popularity of Micron (MU) and Intel (INTC) shares!)

History undoubtedly teaches lessons about investment but it does not say which lesson to apply when.

Investors are challenged by orthodoxy and consensus… or as I like to describe, as “group stink.” Many of the business media are complicit in that it delivers predominantly bullish views (optimism “sells”) – sometimes provided by rigorous participants, but most often by those that deliver a simplistic view of Mr. Market (and usually have their own service to sell).

Let’s not forget that pride goeth before fall – also publicity handshakes and celebrity. Nor shall we forget Theranos and maybe even Tesla (TSLA) .

Many perma bullish “talking heads” possess a silly (and much quoted) view that bearish market analysis rationale always sounds superior to the bullish case. This is a common and much repeated argument that holds little weight.

Always stick to your process and do not deviate from your risk appetite and profile.

As Ben Hunt wrote in Epsilon Theory ( Death in the Afternoon):

“Where there’s shame, for both investing and beekeeping, is not sticking with your process. And if your process is only for getting into an investment or starting a new colony … sorry, but that’s not a process. Investments and animals have a life cycle. Your JOB as an investor and a beekeeper is to be there for the entire life cycle, even for the really hard parts like culling a weak queen or getting out of a weak investment. Even if it’s raining outside.”

We live in an interconnected, networked and flat world – denying the risks of poorly thought out trade policy, the weakness in the Chinese and EU stock markets and the potential contagion from Turkey, Argentina or any emerging market are dangerous based on history and its consequences. Indeed, given global flatness, the odds favor that contagion is less ring fenced today than at any other time in history.

And so is ignoring hastily crafted policy (conflated with politics) by the White House a dangerous leap of faith – it shouldn’t be ignored. Though the body of the Administration seems to have been diseased (in multiple ethical, moral lapses and in other ways), many of those same commentators who dismissed the mortgage derivative problem (a decade ago) suggest ignoring the indictments and guilty pleadings of multiple campaign members of the Trump team and the general culture of corruption that currently exists in Washington, D.C. — that these considerations will have little impact on policy, the balance of power, the economy and our markets.

This may, too, be a dangerous investment route.


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Doug Kass

Doug Kass, since 2004 Doug Kass has served as President of Seabreeze Partners Management, Inc. He runs a hedge fund and individual managed accounts, co-authored “Citibank: The Ralph Nader Report” with Ralph Nader and the Center for the Study of Responsive Law in the 1970s and wrote "Doug Kass: A Life on the Street" two years ago (John Wiley). Since 2003 Mr. Kass served as a guest host on CNBC's "Squawk Box" and has guest hosted Bloomberg's "Market Surveillance" for the last five years. Along with Jim Cramer, Doug is the principal contributor to Real Money Pro.

2018/09/05
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