May 30, 2014

Market conditions similar to 2007

Regardless of the direction of the news flow of fundamental economic or corporate profit data, the markets have moved ever higher over the past few weeks.

    The VIX (and other fear gauges) have dropped consistently.
    The Investors Intelligence bull/bear spread has rapidly expanded.
    IPO activity is back.
    M&A activity is soaring -- the number of deals worth $10 billion or more are higher than both 2000 and 2007.
    Share repurchases have accelerated -- again, thanks to easy money and the funding of equity buybacks by bond borrowings).

All of the above conditions are back to 2007 high levels.

Memories of the last down cycle (and lax lending standards) have grown faint, as evidenced by the quality (and coverage) of the leveraged buyout deals in 2014 having deteriorated, with 40% of private equity leveraged buyouts being done above 6x earnings before interest, taxes, depreciation and amortization and, again, at the highest since 2007. Investment-grade and junk spreads have plummeted, and bond yields have declined to fresh 2014 lows. 


May 29, 2014

Market turmoils and Consensus views

For over five years the Fed and other central bankers around the world have backstopped markets with nearly free money and through quantitative easing.

To some degree, central bankers' efforts have prevented natural price discovery in many asset classes, and their actions have caused investors to lower their guard, adopting something of a false sense of security that the market downside is limited. 

Fueled by new highs and easy money, market observers are now growing more optimistic. Sentiment measures are at or are approaching five-year highs.

But consensus views are often notoriously wrong-footed. As an example, find me the forecaster who called for a 2.50% yield on the 10-year U.S. note and 1905 on the S&P 500 this year, and you would have found a liar.

Over history, a Minsky moment -- that is, market turmoil following an extended period of speculation and/or unsustainable growth -- sometimes occurs when complacency sets in, as stability is often the prelude to instability.

Particularly worrisome is that we might have entered one of the great bull markets in complacency, with enthusiasm rapidly building (as it typically does in a maturing and eventually vulnerable stock market cycle). 

May 19, 2014

Apple proposed acquisition of Beats

Last week Apple announced that it is in advanced talks to pay $3.2 billion to acquire headphone maker and music-streaming service Beats Electronic (co-founded by hip hop artist Dr. Dre and music executive Jimmy Iovine).

There is a tendency to develop extreme observations and make profound conclusions based on every bit of corporate news (no matter how insignificant), particularly as it relates to some of our larger and higher-profiled publicly held companies.

Some of the hyperbolic responses and explanations for the proposed transaction of Beats by Apple are downright silly. I have heard everything from the acquisition is an attempt to launch Apple into the apparel business to this is a way in which Apple will get Jimmy Iovine involved with the company.

My bottom line is that the $3.2 billion transaction is largely irrelevant due to the scale of Apple's market capitalization ($505 billion); sales ($180 billion); cash ($150 billion); earnings before interest, taxes, depreciation and amortization ($65 billion); total assets (above $200 billion); sustainable yearly gross profits ($65 billion) and earnings power; annual capital spend; and so forth.

In light of the fact that the $3.2 billion Apple will spend on Beats is earning nothing in the bank, the deal is slightly accretive.

Beats quality product image is consistent with the Apple brand.

The deal will not move Apple's needle, though. It is not, as described in this ABC coverage, a mega deal.

Nor is the transaction transformative to Apple.

The Beats acquisition is neither a change in strategy nor a statement of floundering innovation within Apple. The Beats acquisition is a rounding error for Apple.

Originally published on

May 15, 2014

Doug Kass likes UK company Monitise

Monitise is a London company that provides a platform for payments on mobile devices. It trades in London and over the counter in the U.S. [MONIF]. I see this as at least a five-bagger. There is probably no larger business than the mobile-payments industry. This company has a market cap of about $1.2 billion, and could well be one of the most important disrupters in the mobile-payments industry. Visa and Visa Europe own about 13% of it. 

Monitise just did a private offering in the U.K. at 68 pence [$1.14] a share. The stock is down a little to about 66 pence. MasterCard has also taken a stake in it. Leon Cooperman, who runs the hedge-fund firm Omega Advisors, has increased his stake to 12% and is the largest shareholder. Monitise, which isn't making money, owing to heavy investment in future growth, has 28 million subscribers. It plans is to have 100 million by 2016, and 200 million by 2018, and it expects fees to go up.

Article originally published on April 26, 2014 on

May 13, 2014

Doug Kass warming to China ETF- FXI

As is very well known, the Chinese stock market has performed poorly both in a relative and an absolute sense over the last five years.

There is no reason to rehash the multiple reasons for the weak performance of China's stock market, such as slowing domestic economic growth, a property bubble, opaque reporting/accounting, etc.

I have spent the last week researching potential opportunities in China and I have concluded that the almost universal (and consensus) hatred for the region's markets and skepticism of China's economic growth trajectory could resemble the consensus (and wrong-footed) short bond thesis that existed at the beginning of this year.

I am seriously considering a meaningful long position in this contrarian play (FXI) based on the following 10 observations and conclusions.

-    The main risk to China's stock market and economy is a weakening property complex that leads to a 10% (or more) decline in construction activity, which will adversely impact related commodities, the industrial complex and local government finances, serving to lower real GDP by 2% (or more).

-    China's property downturn may be more manageable than the consensus believes. The valued economists I speak to are looking for more balanced economic growth of 7.2% real GDP in 2014 and about 6.7% next year.

-    The  probability of a property downturn that leads to real GDP declining to 5% or less (in 2015) is likely only about one in five (20%).

-    Despite general concerns, most indicators of the state of housing (prices/activity) in Tier 1 cities are fairly stable, but fears of Tier 3 cities' inventory-to-sales ratios have risen and have to be monitored.

-    An important positive relating to housing is that the Chinese household sector is not particularly leveraged as most Chinese consumers are using their homes as a vehicle for savings, given the better-than-10% wage growth trends and a favorable taxation of property income in China.

-    The threat of a financial crisis in China might be overplayed given the high degree of liquidity. Non-performing loans in the banking industry are only about 1%. In the public sector, the Chinese government is capable of issuing bonds to battle any liquidity problems at that level.

-    China's labor market has a lot of slack, even though stated unemployment is low, as nearly one quarter of the employed are in the agriculture market. These employed can be transferred into other sectors. Moreover, productivity is still low, leaving room for improvement and sustained economic growth.

-    China's political leaders will not allow too much of a slowdown as they fear social unrest. Property market weakness can be buoyed by easing credit.

-    Political corruption is slowly receding, serving to reduce business costs and improve profitability. Until recently, companies had no discipline on expenses with unlimited spending on corporate boondoggles and gift giving.

-    PBOC is lowering interest rates, doing unsterilized intervention and is comfortable with the current value of the country's currency. 

China price-to-earnings multiples are low.
The sectors within the Chinese market I am looking to buy are in services, e-commerce, automation and mid-level manufacturing. 

For now, I plan to initiate a small starter position in FXI (long) this morning. Probably the only thing keeping me more than my feet wet in China is my general stock market cautiousness.

Article originally published on May 9, 2014 via

May 12, 2014

Whats the future of Facebook Whatsapp merger

Both the AOL-Time Warner and Facebook-WhatsApp mergers predominantly used stock; both mergers were heralded as being transformational.

One merger bombed; the other one will as well.

In the fullness of time, probably sooner than later, the WhatsApp deal will likely yield a $19 billion write-off, mimicking the ill-fated AOL-Time Warner deal.

I use WhatsApp's product/service. It is an instant message chat room, literally nothing more and nothing less. I am not certain, but I believe WhatsApp has no revenue. 

There is always a fine line between insanity and brilliance. In the final analysis, that's what's up with WhatsApp -- it's insanity cubed.

From my perch, I would declare this deal as dead at birth. The transaction stepped over that line and gave fuel to the final bubble-like move in the market leaders early in 2014.

Just as I successfully avoided and shorted AOL on the announcement of the Time Warner merger, I have no interest in ever investing in Facebook, the management of which gave birth to the ludicrous WhatsApp transaction. 


May 9, 2014

Leadership changes in market can signal correction

In early 2000, the market leadership rotated from high tech to value stocks—exactly what has happened in the past two months. Leadership changes are often the sign of a market correction or bear market.

May 7, 2014

Tesla risks and Apple rumors

My interest in Tesla started out when I found something in the fourth-quarter earnings release and the most recent 10-K. Based on my analysis, the company reduced its warranty reserve by a hefty $10.1 million, a gain that flowed directly into the income statement and boosted margins. The stock rose substantially, providing a great short entry point. 

Then there were reports of Apple having had discussions with Tesla, allegedly about possibly acquiring it. To me, that was silly. Nothing has come of the rumor. 

Tesla is being capitalized at about $1.2 million a car, versus roughly $10,000 a car for Ford Motor. A lot of future growth is in Tesla's share price. The narrative has moved to Tesla's plan to build the world's largest battery factory—a risky move. With a market cap of about $26 billion, Tesla has a lot of execution risk and competitive issues. The hope for bulls is that the Gen III vehicle—a lower-priced vehicle [than Tesla's core Model S sedan] to be launched in 2017—will be enormously successful. 

We think the new Tesla will be hit by pricing pressures from incumbent manufacturers with deep resources, which have demonstrated a willingness to lose money on electric vehicles and have a big head start in mass production.

May 6, 2014

Doug Kass likes Ocwen Financial

One of my long holdings is Ocwen Financial [Ticker Symbol: OCN], a leading player in origination and servicing of sub-prime loans. The non-prime mortgage business is likely to undergo a renaissance. 

No company is better positioned than Ocwen, the largest player in sub-prime. Prior to the financial crisis, about 60% of U.S. households could qualify for a prime mortgage, and about 10% could qualify for a sub-prime mortgage. The remaining 30% were renters. 

Post-crisis, approximately 30% of households qualify for a prime mortgage, and sub-prime is almost nonexistent. So unless we're destined to become a nation of renters, something has to change. At the same time, the recent rise in home prices hasn't coincided with income gains for average home buyers. That represents an opportunity for non-prime mortgage companies. 

Gone are the days of low- and no-documentation non-prime loans. Today, these loans are very secure. The non-prime industry space has been abandoned and created a void for Ocwen.


May 5, 2014

Doug Kass says dont buy social media stocks

Despite the recent drop in the Nasdaq, Facebook (FB) still possesses a $140 billion market cap. Twitter's capitalization exceeds $24 billion. 

LinkedIn (LNKD) trades at a market cap of more than $19 billion and a cool 750x earnings. Salesforce (CRM), which has been an awful stock, still has a $32 billion market cap (with financial statements that belong in the clouds because they are so damn confusing). 

Tesla (TSLA), down $60 from its high, is still priced as if gasoline won't have a commercial use in five years. 

Zillow (Z), although its commercials are touching, is priced at 20x sales, and last time I checked, it sells advertising and subscriptions. 

Then there is Yelp YELP, a collection of restaurant (and other) reviews, clocking in at 20x revenue.

Bottom line: Avoid the whole social media space and cover your ears when talking heads, people in flip flops with MBAs and those walking into traffic on their smartphones tell you otherwise.


Doug Kass short JP Morgan Chase

Consider the hedge-fund community's favorite bank, Bank of America [BAC], which I'm short. Its net interest margin, fell to an adjusted 2.29% in the first quarter, and net interest income around $10 billion was disappointing.

FICC activity, which involves trading of fixed income, currencies, and commodities, has been weaker lately for many of them [Banks], including JPMorgan Chase. 

As for credit quality, interest rates, and the yield curve, if all these go in the wrong direction, capital-market activity could be weak. If I'm correct about a market correction, that will put pressure on these banks. Loan demand is tepid and growing slowly, partly because of subpar economic growth and partly because the country's largest companies are very liquid and don't need a lot of credit. Credit quality has improved in the past three or four years, but it's more of a headwind now, as loan-loss provisions start to be less of a benefit. 

That leads us to interest rates and the slope of the yield curve, by far the most important factor for bank profits; it should be the most worrisome area for bank investors and bank profits. 

Article originally published on April 26, 2014 on

May 2, 2014

Can QE deliver the results the Fed is seeking

Share prices have obviously benefited from massive liquidity and a zero interest-rate policy. The recent high-beta earthquake in which stocks sold off was probably the first shot across the bow. Increasingly, the market seems to be realizing that each progressive quantitative easing is having a more restrained impact on growth. 

With rates at zero, QE has become a blunt tool. The Federal Reserve has built a bridge to growth, but it can't deliver the destination on its own. And the flattening of the yield curve tells a story of slowing growth. There is about a 230 basis point [2.3 percentage points] spread between two- and 10-year Treasuries, compared with almost 270 bps at the end of last year. That's signaling muted economic growth.


May 1, 2014

Corporate profit margin concerns

Corporate profits are the mother's milk of stock prices. First, we've had this lengthy improvement in corporate productivity, and that's likely near complete. We've had years of fixed-cost reductions by corporations, and that's also likely over, because they've cut to the bone. If the employment market gradually tightens, labor costs will rise, pressuring margins. Both interest expenses and effective tax rates will have to rise as central banks normalize monetary policy and the U.S. sees the need to reduce its deficit. And a very costly regulatory policy is likely to continue, increasing corporate costs. And finally, the quiescent capital-spending cycle will ultimately be awakened. With that, amortization and depreciation costs will ascend.

We are in a market with no memory from day to day, sometimes from hour to hour. But we are seeing the rotation that we began to see between 1999 and 2000. Warren Buffett was really out of favor when, during the technology and Internet boom in 1997, '98, and '99, people said he had lost his touch. Value stocks were out of favor and tech stocks were in favor, but then, all of a sudden at the beginning of 2000, you began to see a rotation out of high-beta, high-octane stocks, which eventually collapsed into value stocks. In early 2000, that move presaged a late-2000 considerable decline. So, we are moving from a one-way market to a two-way market where you can make money both long and short.