November 30, 2015

Doug Kass latest on Blackstone, MuniBonds, Disney and Gold

Here's a rundown of my latest moves:

I've added to my long of the Blackstone/GSO Strategic Credit closed-end fund (BGB) on nearly every trading day over the last two weeks. As such, my position has now moved to large from medium-sized.

As I mentioned earlier this week, BGB's trading volume has swelled, with more than 500,000 shares traded on both Monday and Tuesday. That could mark a selling climax similar to what we saw in closed-end municipal-bond funds in December 2013.

Muni-Bond Funds
As aggressive as I've been on my BGB long, I've been equally aggressive on the sell side of muni-bond funds. I'm now down to tag ends on most of my muni-fund longs.

I put Walt Disney on my "Best Short Ideas" list this morning at $116.25, but I'm taking off the SPDR Gold Shares ETF  (GLD). 

I'm maintaining a small long on GLD, but can't justify its inclusion on my "Best Ideas" list any more.

Position: Short DIS, Long BGB (large), BLE, BKN, BTT, GLD NPI, NAD, VCV, VPV, ETX, NAD, NMA, NMO, NRK, NPI, NPM, NQU, NQS (all small)


November 26, 2015


I pressed my shorts today on Apple (AAPL)  , Exxon Mobil, MetLife (MET) , Schlumberger, the iShares Russell 2000 ETF (IWM) and the SPDR S&P 500 ETF (SPY) .

I also established new shorts on Starbucks (SBUX - Get Report) , Walt Disney (DIS - Get Report) and the iShares China Large-Cap ETF (FXI) . (Full disclosure: that's a Dennis Gartman fave on the long side.)

I'm also currently offering above-the-market short sales on Goldman Sachs (GS) and Morgan Stanley (MS) , but hadn't executed those trades as of this writing.


Originally published on November 11, 2015 on

November 24, 2015

Market may be in for trouble

Healthy bull markets have broad participation, but unhealthy ones have narrowing participation.

Here's a look at both the technical and fundamental issues that I see facing stocks:

The Technicals: The Rally Has Bad Breadth
The best gauges of market breadth are the advance/decline line and the number of stocks hitting new 52-week highs. 

Strong bull markets exhibit bold cumulative advance/decline lines and expanding 52-week highs, which confirm the highs reached in the broad indices (where large-capitalization stocks dominate). But weak bull markets show breadth that diverges from the big indices on these two measures, failing to confirm the new highs.

To measure this accurately, analysts often look at the relationship between an index's equal-weighted and capitalization-weighted versions. A rising relative line between the two denotes a healthy market, while a declining line means a few large-cap stocks are driving the advance.

This year, the New York Stock Exchange's common-stock-only advance/decline line peaked in May and lagged during the market's recovery from late-September lows.

Moreover, new NYSE 52-week lows have eclipsed new 52-week new highs for some time.... This is a signpost of underlying weakness:

We can also clearly see a declining trend if we compare the S&P 500's equal-weighted and cap-weighted versions. This shows that the index's large-cap components have outperforming their smaller brethren since mid-April -- and remarkably, still made new lows in the face of a 12% recovery in the overall S&P 500:

This raises the question of whether investors should chase the FANGs or the NOSH -- Nike, (NKE), O'Reilly Automotive (ORLY), Starbucks (SBUX) and Home Depot (HD). These stocks could eventually get defanged because the rest of the market might be unusually vulnerable to a correction.

Large-cap quality holdings might work for a longer time. But without support from the majority of lesser stocks, attrition seems likely to eventually take a toll on the market's current leaders. As the old saying about Wall Street's traditional "Santa Claus Rally" goes: "If Santa Claus should fail to call, bears may come to Broad & Wall."

The Fundamentals:  Good News is Great, Bad News Is Even Better?

The fundamental front shows concerns about punk domestic economic data, as seen in weak retail sales, a manufacturing contraction and a possible peak in housing and autos. We also see the prospects for moderating operating profits, slowing Chinese and Eurozone growth rates and a new multiyear low in high-yield bond prices.

On that last point, high-yield bonds are definitely acting "junky." CCC-rated bonds have underperformed BBs over the last 12 months by 700 basis points (and by over 450 basis points ex-energy). There are only three previous instances of such deep underperformance. Two coincide with the mature credit cycles of early 2000 and early 2008 and one was a "false positive" in late 2011.

On the point of slowing global economic growth, Goldman Sachs recently opined that the U.S. economy's natural state has deteriorated from the past and "will remain lower for longer." Indeed, some seven years of monetary easing have served to weaken the economy to the point where secular-growth prospects might be nearly half of what we experienced over the last three to five decades.

Deutsche Bank goes one step further, arguing that after decades of bubbles, reducing the equilibrium real rate of federal funds serves as a negative to growth:

"The real case for policy error -- equilibrium short real rates may be below zero. There are two interpretations of the macroeconomic data that have vastly different implications for the effect of imminent rate hikes. The first is the 'conventional' view, which the Fed subscribes to. This view posits that the short-term real equilibrium rate is around zero. Since the nominal funds rate is at the zero lower bound, policy is accommodative, and this is why the labor market has improved rapidly. Inflation has not picked up because it as a lagging indicator. ...
The alternative view is more worrying. In this view, the equilibrium nominal rate is at present much lower than the Fed thinks, and the equilibrium real rate is meaningfully negative. Policy at present is not very accommodative, and to the extent that it is, inflation is actually running above its equilibrium level, which is close to 1%. ...
This is the important policy-error scenario, because even a very shallow path of rate hikes might drive the real fed funds rate well above the short-term equilibrium real rate, further depressing demand. It is then plausible that the economy would be driven into recession, and the Fed would quickly be forced to abort the hiking cycle."
-- Dominic Konstam, Deutsche Bank

Moreover, there is simply too much debt. Unconventional monetary policy simply expands the debt load and  makes the U.S. economy extremely vulnerable to an interest-rate hike. So, the Fed is trapped.

Meanwhile, the conspicuous flattening in the yield curve is another possible signpost of slowing domestic economic growth and/or a Fed policy error:

The Calm Before the Storm
The bottom line: The "Ah-Ha" Moment, where investors lose faith in central bankers, might be ever closer at hand. Both the technical's and fundamentals are conspiring to form a possible toxic market cocktail.


November 17, 2015

Retailers to be in trouble

I previously wrote about the negative outlook for the traditional retail business -- and Macy's specifically.

The transformation of the delivery of retail goods began glacially but has quickened its pace dramatically in the last 12 to 18 months.

Amazon initially began to transform the delivery system of retail products years ago, but many others have chimed in with strategies that emphasize quicker and less-expensive channels, particularly of an Internet kind.

The debris from this changing backdrop will be voluminous and scattered well beyond the traditional retail businesses. As an example, Whole Foods a market-leading distributor of high-quality, gourmet food products -- was disintermediated weeks ago. There will be many more industries disrupted.

Moreover, this transition has important negative ramifications not only for the retail industry but also for the real estate industry (read: malls and shopping centers); it provided the bricks and mortar that served as a delivery point for goods and a prime source of jobs. These and other sectors will be damaged going forward.

As I mentioned in my morning column, "Macy's Performance Is No Miracle on 34th Street," we are now over-boxed in this Brave New Retailing World, which coalesced in one big thump and dumping in retail stocks after Macy's punk results today.

But Macy's won't be the last victim.

There will be more damage in numerous industries.

As I cited in my Barron's piece four years ago titled "The Threat of Screwflation," technological obsolescence is one of the root causes of the weak jobs market over the last decade.

Stated simply, the quantity of physical and labor capital required to operate a business has changed forever in the world.

No wonder Facebook (FB) has nearly six times the market value of General Motors (GM) .

Position: Short FB (small)

November 16, 2015

Doug Kass buys Macy's shares

Shares of Macy's fell more than 13% yesterday and are now down by nearly 40% for the year. The retailer's weak third-quarter results stunned the markets yesterday and weighed down the entire retail sector.

That said, I purchased a small position in Macy's near yesterday's closing price and plan to slowly accumulate more shares in the days ahead. I'm also adding Macy's to my "Best Ideas" list based on what I see as a favorable risk-vs.-reward ratio.

What's my rationale for these contrarian moves?

Well to begin with, someone could buy Macy's out with the company's own dividend providing the majority of the financing costs. Here's the math:

Current yield: 3.55%
Yield grossed up for taxes: 4.80%
Equity capitalization: $12.5 billion
Net finance cost at 9% (assuming 50% premium): $780 million
Current EBITD: $3.6 billion
Current interest: $400,000
Total interest: $1.18 billion
Capital expenditures*: $1.2 billion
Margin of safety: $1 billion or more

Based on the above, it seems logical to assume that Macy's current share price won't persist for long.

Importantly, Macy's management is quite financially sophisticated -- the company's CFO, in particular, is among the best.

Macy's executives (and several activist investors) recognize the value of the large underlying real estate assets that form the company's foundation. 

My guess is that there are three likely outcomes for Macy's. I think the company will either:
    -consider a leveraged buyout, or

    -partner with a third party, or

    -someone will mount a hostile takeover.

The only other alternative would be a sharp rise in Macy's share price, but that seems unlikely given the low valuations and investors' current disdain for retail stocks.

So, I rate the probability of one of the three events above occurring as high as 75%, even before Macy's releases its year-end results in late February 2016.

The only real negative to my thesis is that a number of retail LBOs have been disasters. However, the big risk in previous retail LBOs -- surging inflation in merchandise costs -- isn't a problem right now.

And what makes me confident about my Macy's investment thesis is that the company's business isn't in a freefall. As Jim "El Capitan" Cramer recently noted, U.S. household net worths are improving and jobs and income growth are satisfactory.

Sales to non-U.S. customers (a 1.5% headwind to sales) are also probably seeing close-to-peak relative strength in the U.S. dollar. I don't believe the euro is going to $0.80, nor the yen to 160 to the dollar.

Moreover, Macy's recent sales weakness was accentuated by unusually warm weather that caused poor traffic for cold-weather apparel. But the chain will mark those goods down during the fourth quarter ("when the ducks are flying").

Management also used relatively austere forecasts in its downward guidance this week. So, it's highly likely that given what will be a very promotional holiday period, Macy's sales will come in well above the forecast -2% comp level. It's also probable that while at Macy's, holiday bargain hunters will find their way to some full-priced merchandise.

Another plus: Macy's is currently selling at under 6x trailing 12-month EBITD. So, the return on buying the stock is 16%+, while the current dividend adds another 3.5%.

To me, that means Macy's could be the best buy on a relative basis to other retailers following yesterday's large price drop.

After all, chains that sell stuff consumers buy to eat currently trade at around 10x to 17x EBITD, while "do-it-yourself" stores fetch about 10x to 14x and autos go for 8x to 11x. But chains like Macy's that sell stuff that goes on the body (i.e., apparel) are trading for just 6x to 8x.

As little Susan Walker put it in Miracle on 34th Street: "I believe. I believe. It's silly, but I believe!"


November 10, 2015

Quality of earnings should matter more

There are often profound differences in GAAP vs. non-GAAP accounting, especially among technology and social-media companies.

But David Einhorn of Greenlight Capital recently noted that this creates some big questions for investors, writing:

    "Would these companies be able to retain their highly talented workforces if they stopped doling out large amounts of equity? If you are trying to determine the creditworthiness of these ventures, it might make sense to back out non-cash expenses. But if you are an equity holder trying to value the businesses as a multiple of profits, how can you ignore the real cost of future dilution that comes from paying the employees in stock?"

Bull markets are forgiving of non-GAAP accounting -- but in a bull run's later stages, the irrational is often rationalized.

During periods of market optimism, investors rarely stop to reflect on the quality of earnings. They don't bat an eye at a falling effective tax rate, the absence of organic growth (often covered up by a "roll-up" strategy of serial acquisitions) or a vast gap between non-GAAP and GAAP accounting or other bookkeeping conventions.

But as we're learning from Valeant Pharmaceuticals, Sun Edison, some energy MLP's and other stocks, introspection can be painful when the alleged fantasy numbers are discovered.

As I recently wrote on the subject of roll-ups:

    "Zero interest rates, massive liquidity and slow global economic growth breed financial engineering, accelerated M&A activity and the proliferation of 'roll-up' strategies. That's where companies boost earnings not through organic growth, but via acquisitions.

    The breeding ground for roll-ups is a flourishing mid-business-cycle condition, when liquidity is abundant, the stock market is euphoric, there's little introspection and less of a focus on earnings quality.

    But problems often get exposed later in the business cycle. Accounting issues tend to arise toward a bull market's end after companies that used roll-up strategies have problems growing sales and profits further.

    Marginal and/or aggressive executives with questionable business ethics often cut corners and take advantage of accounting conventions. But as the cycle matures and credit markets tighten -- as we're seeing now with widening spreads between investment-grade and high-yield bonds -- roll-ups often turn sour.

    Recent questions surrounding Valeant Pharmaceuticals and SunEdison could be examples of this. For all we know, so could the U.S. Securities and Exchange Commission's investigation of revenue recognition at IBM (IBM - Get Report) . Other firms will likely also face questions as well.

    -- Doug's Daily Diary, A Word About Roll-Ups (Oct. 29, 2015)

Back in June, Barron's Andrew Bary also wrote an excellent article on non-GAAP accounting: How Much Do Silicon Valley Firms Really Earn? And on Sunday, Gretchen Morgenson of The New York Times discussed Valeant's aggressive accounting tactics in this well-documented article.

I was originally turned on to the issue of corporate accounting by Dr. Abraham Briloff. His seminal book, Unaccountable Accounting: Games Accountants Play, and his series of scathing accounting articles in Barron's formed the basis for (and my interest in) the subject of earnings quality. Indeed, I spend much time on this subject in an MBA textbook I'm currently writing.

Technology companies -- emerging and rapidly growing social-media stocks in particular -- are among those that deliver the most aggressive and at times fanciful non-GAAP earnings reports these days.


November 9, 2015

US Dollar strength to hurt profits of Consumer Staples

I am of the view that the U.S. dollar will continue to rise and jeopardize multinational corporate profits.

At the epicenter of the U.S. dollar pressure are consumer nondurable companies. Consumer staples also face damaged moats of more generics and cheaper non-branded products to their formerly impenetrable lines of businesses.

Look at the shares of Procter & Gamble, Colgate-Palmolive, PepsiCo and Coca-Cola today; this could be the tip of the iceberg of poor absolute and relative performance.

I have shorted Consumer Staples Select Sector SPDR ETF to get representation in this short theme.

November 2, 2015

Doug Kass explains short Apple reason

Apple gave something for both the bulls and the bears in its fiscal fourth-quarter earnings....For the bulls, Apple's $1.96 earnings per share slightly exceeded the $1.88 consensus expectations. And as Tim Cook recently mentioned in an e-mail to Jim "El Capitan" Cramer, China sales were robust -- doubling from the year ago period.

However, the $12.5 billion in quarterly China sales were down from $13.2 billion in the previous period and from the +120% year-over-year increase. And while the company noted that the upcoming quarter's iPhone sales will exhibit an advance over the prior year's stellar results, management gave conservative forward guidance overall (as is typical).

Bears will also note that iPhone unit sales' year-over-year growth rate has decelerated over the last four quarters, from 46% in fiscal 1Q to 40% in fiscal 2Q, 35% in fiscal 3Q and 22% in the latest period.

Further, the company modestly missed analysts' unit estimates in every major product line:

    iPhone: 48 million units vs. 49 million expected
    iPad: 9.9 million vs. a 10 million estimate (down 20% year over year)
    Mac: 5.7 million vs. 5.85 million projected (up 3% year over year)

Revenue came in slightly ahead of some analyst estimates despite these misses only because the company's "Other Income" line expanded.

Why I'm Short on Apple

Personally, I continue to look at Apple through the prism of a bear. The key to my short case for the stock lies in the notion that the most-recent product upgrade cycle was the last important one that Apple will see over the next few years.

While the iPhone 7 lies ahead for fiscal 2016, I don't expect we'll see much of a technological change from the iPhone 6. And I don't see a compelling reason to upgrade to an iPhone 7 despite the iPhone 6's relatively low penetration rate (28%) among Apple's existing installed base.

At the same time, ancillary businesses (iWatch, Apple Pay, Apple TV, Apple Music and even the Apple car) won't likely be earnings "needle movers," nor materially offset the absence of growth in the company's core iPhone division during 2016-17.

And while Apple's "Other Business" line contributed about $3 billion in the latest quarter, that's a large figure for most companies but not for Apple -- which had $51 billion in total revenues. Indeed, in looking at the non-core businesses, it's not even clear to me that music will survive.

And even though penetration into China is a plus that will make a strong contribution to Apple's top-line sales growth over the next few quarters, the overall smart-phone market is maturing (particularly at the high ASP level).

My Forecast

As a result, I expect Apple's top- and bottom-line growth over the next two to three years to dramatically moderate from what we saw over the last two to three years.

Despite fiscal year 2015's 42% growth EPS rate, I expect flattish Apple profits of about about $9.50 per share in fiscal 2016 vs. $9.22 this time around. I also predict revenues will come in essentially unchanged at $235 billion next fiscal year vs. $233 billion in this one.

Sales might be flat in fiscal 2017 as well, with EPS benefiting from continued share buybacks and growing about 8% to roughly $10.25 a share.

Overall, I think that while Apple's fiscal 2015 sales totaled $234 billion, revenues will likely only reach about $250 billion by fiscal 2018. That's a small, 8% cumulative advance.

The Pros and Cons of Cash

Of course, much is made of Apple's cash horde, which provides a safety net for investors.  It's true that all of that cash provides a continued buyback opportunity for the company, and pressure from Carl Icahn and others will pressure management to continue share repurchases.

However, should Apple decide to make a major acquisition, that could be valuation destructive -- as it would underscore the company's "maturing-market" theme.

While Apple's valuation is around 12x projected 2016 EPS (less than the overall market's average), a maturing company of Apple's size in terms of sales and market capitalization deserves a substantially lower market multiple.

The Bottom Line

As I've previously written, Apple suffers from its prior successes and the "Law of Large Numbers," which I expect we'll began to see in the company's next quarterly report. It is tautological that the needle of sales/profits/cash flow will be ever harder for management to move.

Finally, who's left to buy Apple stock? And conversely, the shares could continue to be an ATM for investors who'll sell their AAPL stock if the bull market fades.

Position: Short AAPL