Tonight, I am taking matters into my own hands. I am actually going to say some things that are positive about the market but totally at odds with what you saw on your screen today.
But here's a caveat. In the short term, nothing I say will mean a thing to you if you have a 10-day horizon. To explain this I am going to go back to the days when I ran a half-billion-dollar hedge fund. I am going to explain what would happen each morning when I reviewed our positions, meaning what we would own, with Karen Cramer, who ran the trading desk and was about as exacting and rigorous an individual as I have ever met.
The meetings were ugly. They were hideous. They were pointed. And they were dead right.
We would always start the meeting with a query. She would ask my worldview and my intermediate-term view of that worldview. Translation: What do you think is going to happen in the world and how will it affect stocks in the intermediate term? To her, this meant over the next month or two.
I would then expound on my worldview and its timeframe. We would then methodically review the investments in the portfolio within the timeframe of that worldview.
Mind you, I said investments because Karen always had trades on the sheets, stocks that were catalyst-driven, an upcoming earnings report we thought would be good, a positive analyst day ahead, a product cycle launch that might be well received -- think Apple (AAPL) and all of its fabulous launches.
The trading positions, because they were not responsive to the intermediate-term worldview, could be at odds with the investment positions. If we thought, say, that a particular oil company would have an amazing quarter because it had fantastic properties and was pumping like mad at prices that could still be profitable, we might actually make a trade in it ahead of that report. However, we tried not to go too far against the grain when we made those trades
I am presuming, for the moment, that we are not talking about trading. That's not what most of you do and I have said over and over again that if you are going to trade, you have to be much more hands-on than most of you can be.
What would my intermediate-term worldview say?
First, we are in a vicious commodity price decline of all kinds. Copper, aluminum, iron ore, oil and all of its derivatives -- natural gas, propane methane, all the poly and ethyl plastics, you name it. Given that, our country is more of a taker of these commodities; that's a positive, not a negative. If we were a producer of these commodities, like, say, Brazil, we would be in huge trouble. However, maybe 70% of our economy is service-oriented so that's helped by lower commodities. Most of our manufacturers buy commodities, not sell them. About 10% of our economy does produce these products, and about 15% of the stocks in the market are perceived as winners with higher commodity prices, including, of course, all of the cascading oils. I have been upfront in saying that I no longer believe that oil can sustain these levels because I did not perceive that the Saudis would be willing to flood the world with oil just to break our country's attempts at energy independence and to frustrate the nascent Iranian oil industry. Remember, the Saudis regard our flirting with Iran as taking the other side, so it isn't just economics driving their decision to put a lot of our oil companies out of business. Judging by the action today, where oil plummeted to $40 -- down almost two bucks to a level that is still unsupportable given Saudi pumping -- we can regard this entire move as very positive for the vast majority of our companies.
Right then in our meetings, Karen would say, "You understand that we will lose money in the stocks of any and all oil companies with that view." I would most likely argue that we should maintain a couple of the cheapest ones or the best yields. But when we would review the portfolio again at lunch (we reviewed it three times a day), they would all be gone from the sheets because they differed with the worldview. They tended to be sold when I went outside and bought her a soft pretzel or ran an errand for her because she was too busy trading. I would learn of the sales when we did our review. There would be no argument because she would say, "Hey, you want them back on the sheets, go buy them." But I never did because I shouldn't have owned them in the first place.
Second, I would say that my worldview includes the Fed tightening in the September meeting because housing and employment are strong and they might not care about what's happening overseas. She would then say, "No kidding," although she would most likely insert a curse word or two, and add, "That's what's happening on your screen. Can't you tell? That's the selloff we are having. People smarter than you and run more money than us are getting out of what will be hurt when the Fed tightens, so when it happens they will be prepared. You have eyes, don't you? Use them. You have a brain, put it to use."
Then I would say, "Well, we better get out of the stocks that would be hurt by a tightening." And I could hear her breathe fire while saying, "Given the destruction we have already seen in the market, and how low our interest rates are, perhaps we should be thinking about what's been sold out and what can rally, especially if there is no tightening."
In other words, she was saying it could be a win-win: a win if they tighten because the stocks are really beginning to reflect that tightening or a win if they don't because most people aren't prepared for that occurrence.
I would counter that China is falling apart because the government is trying to prop up stocks that deserve to be much lower, and that's going to cause a big worldwide slowdown in what the Chinese buy. She would answer with, "OK, that's the commodity decline we are seeing, and if the Chinese economy crashes, it will take that complex further down. But many non-commodity stocks are reflecting a dramatic fall-off in business already, so let's find some stocks that are too sold down."
I would then realize what she was doing was trying to get me to think counterintuitively about what I saw on my screen. Instead of being stuck in house of pain, try to think about what could go higher over the next couple of months because of that worldview.
I would have to conclude that we should be buyers of stocks that do well in deflation: food, drug, biotech, extreme-growth tech. Put another way: General Mills (GIS), McKesson (MCK), Bristol-Myers (BMY), Celgene (CELG), Google (GOOG, GOOGL) without China, and Netflix (NFLX), again without China. And I would conclude that we needed to buy stocks with high yields because they would be terrific bond-market equivalents: Kimberly-Clark (KMB), Clorox (CLX), Ventas (VTR), American Electric Power (AEP) and Dominion (D).
Finally, I would say we needed to buy the stocks of companies that are gigantic users of the declining commodities, or consumers who have more disposable income because of lower gasoline prices. And we need to buy companies and individuals that would benefit from the lower-interest-rate environment that goes with the worldview -- homebuilders and the retailers that sell into the homes, restaurants, and airlines and consumer-packaged goods companies that use a lot of commodities. Or, Toll Brothers (TOL) and Lennar (LEN), Home Depot (HD), Lowe's (LOW) and Target (TGT) -- and yes, both were good. Lowe's had an OK number but excellent guidance. Target had a fabulous number but very conservative guidance. Southwest Airlines (LUV) too, because it has the least exposure to the strong dollar among the major airlines.
Then, the meeting would be over.
We would then have to be true to that worldview at every meeting -- no deviations, unless something major changed.
You see, the meetings were about not what was happening now but what would happen, and they would produce very different results from what you saw on your screen. We compounded at 24% after all fees with that method, vs. 8% for the S&P 500.
Let's just say it worked.
