September 30, 2014

10 Reasons to raise cash levels

Unlike others, I don't approach my investment conclusion with self-confidence. While I am explicit in the reasons for my caution ("Sell Strength"), these are my strong views. But I may be wrong, as the only certainty is the lack of certainty. That is why I always qualify my views and average into positions:

-    A market bounce is possible at any time, as the market's character has changed.

-    We are in a market without memory from day to day. Mr. Market will be increasingly volatile and unpredictable. Opportunistic trading may trump buy-and-hold investing.

-    A rally should be sold, as expressed in "Sell Strength." (Short-selling is not for many, but most should consider erring on the side of conservatism.)

-    The market's internals have been deteriorating for months (a constant theme of mine). The accumulated advance/decline line (breadth) has been weakening, the Russell 2000 Index's drop has presaged today's schmeissing, and the number of new highs has contracted.

-    The erosion in the high-yield market is an important and negative development.

-    The world has grown increasingly unsafe. This is not likely to change for years.

-    The market's multiyear advance has benefited from the rising role of high-frequency trading and momentum-based strategies. A downturn could have the opposite effect in a herd-dominated investor base.

-    Global economic growth is moderating and the European economies are problematic. In its extreme, the leveraged European banks represent systemic risk.

-    Before today's schmeissing, few investors envisioned the possibility of a major market correction.

- Our political leaders have failed us. The burden of growth now lies on monetary policy, which is losing its effectiveness. The Fed's zero-interest-rate policy (ZIRP) is not a permanent condition.


Adding up these 10 conditions, I conclude that most investors should maintain above-average cash reserves. 


VIA http://www.thestreet.com/story/12894265/1/top-10-reasons-for-being-cautious-an-oldie-but-goodie-best-of-kass.html

September 29, 2014

Technical divergences and breadth reductions

As previously noted, I am a (short) seller on any strength. As a measure of my conviction, in "Batten Down the Hatches," I reported that I even sold off a portion of some core investment holdings over the last two days, including Radian Group (RDN), Monitise (MONIF), Potash (POT) and Citigroup (C). (These stocks remain on my Best Ideas List, however, because of their intermediate-term reward vs. risk).

I was amused that several commentators in the business media this week couldn't find specific reasons for the recent market drops. By contrast, I see not only weighty technical divergences and narrowing breadth but also a host of fundamental concerns: 

  -  Away from the U.S., economic activity is weakening. Italy, France, Spain, Russia and Japan are in recession. European real gross domestic product growth is perilously close to zero and a Japanese-style deflation is threatening the region. Based on recent data, the rate of growth in China's economy is decelerating. (I recently sold my iShares FTSE/Xinhua China 25 Index (FXI) long at around $42.50 for a near 25% gain over a three-month period.)
  
 -  The European Central Bank faces the challenge of structural issues. The ECB may be running out of gimmicks to spur growth in the quarters ahead. Moreover, the region's leveraged banking complex represents systemic economic risk for Europe and the world. Should the European Union fall back into recession, global economic activity will slow and will not only serve as a headwind to the U.S. and European profit growth, but it will also make it hard for peripheral EU countries to access capital markets and to finance deficits.
  
 -  Geopolitical pressures are rising outside of the U.S. and, unfortunately, there are plenty of reasons to believe that the world will be a powder keg for years. The Russian-Ukraine military confrontation is pressuring trade and economic growth -- that conflict, too, will likely be with us for some time.

-   Housing activity continues to pause, and its foundation is fragile. Increased bank-capital requirements -- above those demanded under international banking regulations -- will further pressure the U.S. housing market and could tighten lending standards. (Mortgage purchase applications are down by 16% year to date)

-   The automobile industry is exhibiting signs of peaking, and so are other durables, such as tractors and other heavy equipment, as posted in Caterpillar's (CAT) recent dealer statistics. Automobile inventory supplies are high and increasing, and aggressive incentives are being offered by car dealers and manufactures.

 -   A strengthening U.S. dollar is dulling our economy's prospects by hobbling U.S. export growth.
    Domestic growth remains sub-par and at "escape velocity," and sustainable growth still seems in question. With the 2014 results, the Federal Reserve itself has missed its U.S. economic growth forecasts for the fifth consecutive year.

-    Inflation continues to run below the Fed's projections and, with the U.S. dollar strengthening and commodities collapsing in recent months, measured inflation is likely to continue lower.

-    Personal consumption expenditures, in particular, look to be weakening. Payroll growth has fallen for the past three months, spending fell in July and August, and the screwflation of the middle class has persisted. The "exclusive prosperity" of trickle up economic policy since the Great Recession holds economic and social risks. None of these effects are likely to be value inflating for stocks.


Originally published Sep 25, 2014
VIA http://www.thestreet.com/story/12892450/1/real-money-pros-doug-kass-on-the-market-sell-any-strength.html 

September 24, 2014

US economy weak and troubles brewing

According to Doug Kass recent post on TheStreet, the following are the reasons Doug Kass believes the US economy fundamentals are weaker than most people believe.

• Away from the U.S., economic activity is weakening. Italy, France, Spain, Russia and Japan are in recession. European real gross domestic product growth is perilously close to zero and a Japanese-style deflation is threatening the region. China's economic growth is decelerating.

• The European Central Bank faces the challenge of structural issues. The ECB may be running out of gimmicks and could be unable to spur growth in the quarters ahead. 

• Geopolitical pressures are rising outside of the U.S. The Russian-Ukraine military confrontation is pressuring trade and economic growth.

• Housing activity continues to pause, and its foundation is fragile. Increased bank-capital requirements -- above those demanded under international banking regulations -- will further pressure the U.S. housing market and could tighten lending standards.

• The automobile industry is exhibiting signs of peaking. Inventory supplies are high and increasing, and aggressive incentives are being offered by car dealers and manufactures.

• A strengthening U.S. dollar is dulling our economy's prospects by hobbling U.S. export growth.

• Domestic growth remains sub-par and at "escape velocity," and sustainable growth still seems in question. With the 2014 results, the Federal Reserve itself has missed its U.S. economic growth forecasts for the fifth consecutive year.

• Inflation continues to run below the Fed's projections, and, with the U.S. dollar strengthening and commodities collapsing in recent months, measured inflation is likely to continue lower.

• Personal consumption expenditures, in particular, look to be weakening. Payroll growth has fallen for the past three months, spending fell in July and August, and the "screwflation of the middle class" has persisted. The recent rise in the price of oil could likewise inhibit retail activity. 


VIA http://www.thestreet.com/story/12886439/1/fed-unlikely-to-rock-the-boat-why-i-am-back-to-shorting-best-of-kass.html

September 23, 2014

Doug Kass post FOMC actions

Though the Federal Open Market Committee language is generally unchanged, I added back my S&P 500 (SPY) short and long ProShares UltraShort QQQ (QID). I did this principally based on the lifting in expectations for the federal funds rate to 1.375% by year-end 2015. 

The new fed funds forecast represents a larger gap relative to the federal funds futures market. This means the markets are behind the Fed in terms of tightening expectations.

Oddly, while gold, oil, the dollar and bonds took this as more hawkish, the U.S. stock market did not (and rallied).

My guess is that the stock market will come around and trade lower (after an impressive rally from the lows of 12-13 handles) on the higher fed funds forecast. 



Article originally published on Sep 17, 2014 

VIA http://www.thestreet.com/story/12886439/1/fed-unlikely-to-rock-the-boat-why-i-am-back-to-shorting-best-of-kass.html

September 22, 2014

Are the best days of Apple behind it

Let me also make it clear that I expect Apple to underperform the markets, but I don't expect Apple's shares to drop from $100 to $55, which would be similar to its decline from September 2012 to May 2013.

I am simply of the view that Apple's shares are overpriced within the context of an expensive U.S. stock market.

At the core of my concern is that Apple's past successes are not likely to be repeated in the future.

The company's sales base has grown so large that Apple is not likely to benefit from the introduction of new needle-moving products. The competitive landscape has changed in the last few years, and Apple's core product (the iPhone) lacks superiority relative to its competition. As a result, Apple's earnings growth is settling down to a more modest path relative to history and to overall corporate profits, and its near-record-high P/E ratio is inflated."

Apart from the sensational title (and reference to doomsayers, which I am not), I felt the Barron's piece was fair, though I disagree with its conclusions. Barron's pushback (and the pushback from other Apple bulls) last week was reminiscent, and no different to, the response I experienced in my bear case for Apple in September 2012, prior to a more than 40% drop in Apple's share price.

At the core of my original argument two years ago was that Apple's shares were overhyped and headed for a fall (and did) as:

-    The competitive landscape was growing more challenging (it did).
-    Apple would start to lose global market share at a faster pace (it did, dropping from about 17% to 12%).
-    The above would reduce profit margins (to be fair, Ray highlighted this, too) that peaked at 44% in 2012 and now are about 38% (so I was correct on this score as well).
-    The above would also result in the absence of big consensus beats in sales and profits, which have characterized the prior five years (the company failed to materially beat in ensuing quarters). 

At the core of my argument in last week's Diary post is my belief that Apple shares will underperform the market:

-    Competitors continue to make market-share inroads into a company (Apple) that sells less for more.
-    Apple's P/E ratio has expanded in the last six months (as Ray noted) and has likely discounted a strong iPhone 6 product upgrade cycle.
-    The iPhone 6 upgrade will likely be the last major upgrade for the company (and valuations, which have expanded in recent months, will contract in the period ahead).
-    Profit margins will continue to slip.
-    After about two quarters of consensus meeting or beating (investor expectations) the upgrade cycle, Apple will continue to lose market share.
-    Apple has challenges to moving the overall needle with new products given the size of the company (each product launch has had a more limited impact on results).
-    Apple is no longer an innovator, and a strategy of selling less for more is not sustainable and does not merit the largest market cap in the world. Selling less for more has already resulted in drastic share loss. Being a market-share loser does not merit the largest market cap in the world. 

Though it's down to 10% in global market share, Apple will remain a strong ecosystem in which consumers continue to upgrade their products regularly. But the near-90% repeat upgrades is exposed and has likely peaked. So will the annual EPS growth of the last five years ever be repeated? EPS growth, which averaged 40% per year in the past five years, is likely to fall into the +5% to +10% range in the next five years, at best , and has a real risk of shrinking after this cycle completes.

Ray uses the argument that Apple's share-price rebound this year is proof that my analysis in 2012 might be wrong. The reality is that Apple has consistently lost market share since my bear case was initially presented two years ago. I think he mixes apples with oranges using this argument, especially since I purchased the stock after being badly beaten up in early 2013.

Apart from the hyperbolic title of the Barron's piece, I thought it was fair. But I stand by my investment conclusion and analysis, and I even look forward to "debating" my buddy Tiernan Ray in the future.

Apple remains all about the iPhone. All the ancillary businesses -- Apple Watch, Apple Pay, HealthKit, HomeKit and the rest -- make customers feel more tied to the iPhone and tells me that the company's installed base will continue to upgrade (albeit at a lesser rate than in the past). You may tell me me that the stock is going up, but don't tell me an overpriced, underspec'd phone that's two years late to the market will forever keep its competitive position and lead.

As evidenced by the brand loyalty (nearly 90% of Apple iPhone users upgrade with another iPhone), for years Apple's success with the iPhone has not been a race to the best technical specs; several manufacturers have offered phones with superior features over the past few years. (As an example, the Q8 processor is a sixth smaller and Apple has stopped adding transistors to the core CPU to extend battery life).

For years, the customer's ease of use (better software and integration) has trumped fewer features at a higher price. This might change in the years ahead. After all, when you are competing based on hardware differentiation, you are a hardware company.

And if it does change, it could jeopardize Apple's core base.

The culture of disruption is often replaced by Apple's past spectacular successes, and its resulting size represents one of the largest headwinds to future growth. The culture of disruption is often replaced by bureaucracy. In that setting, ambitious missions, disruptive goals and spectacular innovation are often left behind.

We can see evidence of the perception of the company's growing maturity by looking at a 15-year price chart of Apple and peg it to these product introduction dates:

    -iTunes, January 2001
    -iPod, October 2001
    -iPod Nano, January 2005
    -iPhone, February 2007
    -iPad, April 2010

If we discount the market crashes of 2001 and 2008, the chart indicates a steady narrowing of the share-price gains from each successive product launch. Meanwhile, research and development expenses continue to climb to sustain the older products, leaving less in each cycle for investment in disruptive technologies.

Not surprisingly, Apple has reported strong initial demand for the iPhone 6 in the last few days, yet the shares have actually fallen. This could be evidence that investors are paying heed to my concern that shares are "overowned" and/or there are few marginal buyers left.

Apple's best days (for the company and the shares) might be behind it, and that its virtuous cycle (with customers, subsidizing telecoms and shareholders) may be ending.


VIA http://www.thestreet.com/story/12882529/1/real-money-pros-doug-kass-i-stand-by-my-apple-call.html

September 17, 2014

10 Year note to 2.75 percent by end of 2014

Despite protestations for lower interest rates (from many who saw higher rates eight months ago), the yield on the 10-year U.S. note is climbing further this morning and is approaching 2.60%.

As I suggested when I put ProShares Short 20+ Year Treasury  (TBF) on the Best Ideas list at $27.21 two weeks ago (now trading at $28.32), I expect the 10-year U.S. note yield to approximate 2.75% at year's end.

I view my short bond position as a multiple year play. 



Doug Kass was was long TBF at time of original post.

VIA http://www.thestreet.com/story/12878384/1/risks-for-an-early-fall-10-year-yield-watch-best-of-kass.html

September 15, 2014

The aging bull market continues

We are now five weeks into the rally from the August lows. Cyclical stocks, housing and industrials have begun to under-perform. This is the nature of these groups and is also evidence of an aging bull market.

As mentioned last week, divergences have developed, mainly characterized by lagging breadth and new highs on the Nasdaq and in small-cap land. Thus far, this has not produced a marked trend change in the market, as the favoring of large-caps has been overcome by rotational moves.

Meanwhile, most gauges of investor sentiment have moved into the excessive bullish arena and have reached levels last seen in late 2013, before the January 2014 correction.

Strategists are nearly unanimously bullish, as evidence by Barron's' recent cover and cover story. 

Bottom line: We are in a bull market in complacency.

    -Few are considering a correction in excess of a few percent.
    -Investor expectations are elevated.
    -Momentum is waning in the face of growing divergences.
    -New IPOs are growing larger (e.g., Alibaba) and more numerous, sopping up potential demand.
    -And the U.S. stock market is growing overbought.

While continued rotation and market selectivity might continue to buoy stocks, market risks are accumulating for the September-October period.


At the time of original post, Doug Kass was long QID and short QQQ.

VIA http://www.thestreet.com/story/12878384/1/risks-for-an-early-fall-10-year-yield-watch-best-of-kass.html



September 9, 2014

Doug Kass vs Talking head geniuses on TV

I continue to watch with amazement the talking heads on various business media outlets -- so self-confident in view on so many disparate subjects. (I like to think that I know what I know and I don't know what I don't know!)

Too many are 3 miles long but only an inch deep and are fixed/complacent in view (rarely considering adverse outcomes).

I wish the game was that easy, and I wish the investment mosaic was so simple.

As I have always written, the only certainty is the lack of certainty.

Perhaps that explains my conservative risk profile and why I size positions relatively small and stay diversified.

And it helps to explain why I view fundamental analysis (though time- and labor-intensive) as a superior investment tool for me. 

September 8, 2014

Doug Kass likes other assets compared to Gold

For some reason I have received an abundance of subscriber emails this week asking me about my thoughts on the direction of the price of gold. I suppose it might be due to the unexpected breakdown in the commodity's price in the face of rising geopolitical tension around the globe.

Back in the fall of 2011, gold (as an asset class) was embraced as an investment just as energetically as price momentum investors have clutched on to social media stocks today, with gusto from hedge funds (John Paulson et al.), other institutional investors and, of course, the retail lemmings.


In theory, gold is thought to prosper and be a valuable asset in a world of too much cowbell (monetary stimulation and solutions), where fear is rampant and the integrity of most currencies is waning in the face of the failure of governments to address fiscal imbalances.

As I have written in the past, gold doesn't produce profits and, as such, fails to provide a stream of income, so it's hard for me to estimate the price level that provides intrinsic value and next to impossible for me to invest or trade it.

Gold is among some other asset classes that will never produce anything but that are purchased in the buyer's hope that someone else, who also knows that the assets will be forever unproductive, will pay more for them in the future. (For example, tulips were briefly a favorite of speculative buyers in the seventeenth century.)

The success of gold requires an expanding pool of buyers, who, in turn, are enticed because they believe the buying pool will expand still further. Owners are not inspired by what the asset itself can produce -- it will remain lifeless forever -- but rather by the belief that others will desire it even more avidly in the future.

In essence, the gold market is a state of mind. It neither represents a corporate franchise (with a protected moat) that increases in value over time as profits are earned and retained such as, say, Procter & Gamble  (PG_) nor is gold a productive asset, as it doesn't produce profits and, as such, fails to provide a stream of income.

Gold's price in the future is simply dependent upon someone willing to pay more for the asset class compared to its price today.

The bull market in gold has stalled badly, and it might not return for a while.

My advice? Let the gold believers believe while we search into other (more productive) asset classes in which to invest. 


via http://www.thestreet.com/story/12868920/1/worth-its-weight-in-gold.html

September 3, 2014

Could Financial Engineering be cause of Q2 earnings beat

Most of the second-quarter earnings reports are now in, and it appears that S&P earnings rose by about 9.4% (year over year). This gain is about 300 basis points above consensus expectations.

In terms of quality, there was less than meets the eye, with buybacks, lower interest expenses and lower effective tax rates contributing to more than 2% of the 9.4% growth. Productivity gains contributed to a surprising margin expansion of about 3% of the 9.4% earnings per share gain.

Though 2014 results seem destined to beat my expectations, a lot of the gains were through financial engineering (which seemingly should be accorded a lower price earnings multiple vis-a-vis organic growth). 



Originally published at www.thestreet.com/story/12861903/3/hubris-of-market-bulls-second-quarter-big-picture-best-of-kass.html

September 2, 2014

Market showing red flags

I have been clearly (and incorrectly) leaning to the short side in 2014 as stocks have out-shot my price expectations.

Many times in my four decades of investment experience, I have seen the sort of hubris that is demonstrated these days, but rarely to such a degree.

It is a clear and unqualified red flag, especially when markets are faced with the reality of a number of headwinds (including unsustainable profit margins), a world plagued with serious geopolitical risks and threats, domestic and economic growth that remains sub-par (despite aggressive central banker policy five years into the economic cycle), inflated valuations (against normalized earnings power), and other issues.

While I have not added to my index shorts, I have lifted my net short exposure by taking some of my gains in several longs, including Citigroup  (C) and Bon-Ton Stores  (BONT). 


via http://www.thestreet.com/story/12861903/2/hubris-of-market-bulls-second-quarter-big-picture-best-of-kass.html

September 1, 2014

Debt yield trading

The grab for yield has gone nuts. Spanish debt is S&P rated BBB, 8 levels below AAA but Spain sells 50 yr maturity bonds at 4%

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