Why Good Companies Can Have Bad Stocks

 | Apr 08, 2014 | 3:50 PM EDT
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Let's speak of wounded money managers and the stocks you might own. Let's flesh out the dislocations between what might be on your stock screener and what is reality. We have to do that to explain these recent sessions, including this one.

Most people immediately want to tie the action of a stock to a company. I believe that some of that is a quaint, atavistic approach to the market, one that must be shaken if you are ever going to make peace with your portfolio.

First, I've been watching two consistent stocks, ones that I like very much, get really banged up here: Time Warner (TWX) and CBS (CBS). I have been searching up and down about what's the heck is wrong with these two. Time Warner is such a winner, it's got a big dividend coming from its Time spinoff, it's making oodles of money in all of its businesses, and it has been one of the greatest buyers of its own stock. Jeff Bewkes has developed some of the greatest hit programming of all time, including Game of Thrones, and the company's HBO Go is a remarkable way of amortizing content. Premium and ad-supported -- just what the market wants.

CBS? It's a hit machine with series after series being generated that can then be repackaged and sent overseas. It's a money-coiner. Darned company still makes more than $20 million a year from I Love Lucy, a television show from 55 years ago.

But these stocks have been under tremendous pressure of late. I've been asking everyone, is Time Warner going down because it was supposed to get a bigger dividend from Time Inc.? Is it because Game of Thrones crashed HBO Go? Is CBS getting hit because David Letterman is retiring or because Jimmy Fallon is such a hit for the network we work for, not that I can get a ticket to see it?

Sure enough, I have found the answer, and it isn't any of those reasons. I think it's because of hedge fund redemptions. Just this morning, we learned that Coatue Management, a $7 billion hedge fund I had never even heard of, has been hammered mercilessly and is going to return $2 billion to investors because of the "volatility" among its holdings. As someone who used to be a hedge fund manager, I can tell you that the word "volatility" is code for "Our positions went against us, and we've been laid to waste." That just doesn't sound all that good.

Sure enough, when we peel back the onion, what do we see? How about that CBS and Time Warner are the first and third largest positions? That's right, Coatue has about $856 million in CBS and $707 million in Time Warner, according to recent reports. I am sure that Coatue's problems have more to do with the problems of CBS and Time Warner's stock than anything that Les Moonves, the CEO of CBS, and Time Warner's Bewkes might have done at their companies. This is the classic example of bad holders turning good stocks into weak ones, as opposed to bad fundamentals tripping up stocks that you might own.

Or let's talk about supply. For days on end, I've been talking about this concept of too much stock coming public and being sold by insiders. Yet when I heard a money manager asked directly today about whether supply, specifically insider selling, is playing a role in this selloff, the manager simply shrugged it off, saying it wasn't a factor.

This kind of naivete is shocking to me. If you reach that conclusion, you either weren't a portfolio manager in the year 2000 or you learned absolutely nothing about the era. So let me refresh or enlighten. First, stocks go higher because there is more demand than supply. That's just the way it works. At their basic elements, stocks are just merchandise, no different from sweaters or coats or toilet paper. When there is a scarcity, merchants can charge more for any of those items. When there's a plethora, they have to discount. You think I would have gotten $10 reduced on my Harman bill for Procter & Gamble (PG) products if Procter weren't trying to move them? Do you think that I could get the steal I did on red-hots and message hearts last month if it were a week before Valentine's Day? Watch what happens to that Easter candy in a couple of weeks. You can have all the jelly bellies and chocolate Easter bunnies you want for a fraction of the cost.

Don't believe for a minute that it isn't the same with stocks. When a company comes public, not every share is free to trade. Insiders are locked up, typically for six months. So, at first, all you are trading is the stock that the bankers let trade in order to stimulate demand and even get a pop in the stock. That way, hedge and mutual funds will sell some existing holdings and get in on the IPOs. Of course, there is no give without a get, so the big funds often tacitly agree to buy say, 100,000 shares of FireEye (FEYE) "on the deal" and then 100,000 shares when it comes public for a nice blended average that produces an instant gain at the end of the day. But then over time, stock that insiders own gets unlocked, and suddenly the dam that had kept back the rest of the river is opened, and those who are swimming in the reservoir are drowned with new insider supply.

Of course, insider stock isn't the only stock that's coming out from behind the dam. Over and over again, this beachhead of buyers has been pounded with wave after wave of initial public offerings. Today, mercifully, we had nothing come to the market. But don't worry -- this week is the biggest for IPOs since 2007, a very inauspicious time for the market if you recall, with deals for everything from casual restaurants and software-as-a-service companies to tankers, early stage biotechs, real estate investment trusts, hotels and pharmaceutical companies, and each one is going to cause a selloff in its own industry, as there isn't enough money coming in over the transom for mutual and hedge funds to buy all of this stuff. That's the supply situation writ large.

Finally, as I root around for reasons why the bonds are so strong, meaning interest rates are so low, I keep coming back to waves of money coming in from none other than Russia. I am getting the sense that this Ukraine issue, which was put on the back burner in the face of the rotation, is lurking and causing money to land here from there, but to land in places that distort traditional relationships.

Tomorrow, for example, I believe we will hear from the old Fed minutes that there is little need for the Fed to continue to buy bonds, because things are getting better in the economy. Yet bonds have been roaring higher, and I believe this is because of foreign money, not because the Fed has been buying up supply like mad. But the casual observer of this market says that all of that bond buying signals market softness, and that means sell stocks ahead of the parade of earnings that begins tonight with Alcoa (AA).

Now here's what's amazing. Did you notice that not one single thing here has anything to do with the businesses the stocks are supposed to represent? Not a thing. They might as well be in two different universes. Which is why it's so mystifying to so many and so simple to so few, the ones who lived through other times when the dikes burst and the supply came roaring over our heads and most smaller investors never got to come up for air. 

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