Tactically speaking it's time to look higher, not lower.
On October 4 I wrote a column in my Daily Diary on Real Money Pro entitled "Why I Have Turned More Bullish".
In that missive, I wrote that "2022 has been among the most difficult stock markets to navigate in history." And it still remains challenging!
My lengthy column and analysis was an adaption of a letter that I previously sent out to the Limited Partners of my hedge fund, Seabreeze Capital Partners LP, and included some of my comments made in a Bloomberg interview I had with Tom Keene and Paul Sweeney.
What follows is another adaptation from an email I sent to my investors at Seabreeze over the past weekend, which continues to emphasize my more bullish market view on the capital markets.
The proverbial saying, "silence is golden," is often used in circumstances where it is thought that saying nothing is preferable to speaking. Silence, unfortunately, is all too often the province of the hedge fund industry.
Silence and opaqueness are not endorsed at Seabreeze -- we endeavor to be transparent in outlook and in the composition and positioning of our portfolio. Sometimes, we go overboard, as we did in last month's 22 page commentary -- but you can always go to the summary!
I take my charge of managing a portion of my Limited Partners' hard earned capital seriously and believe they are "owed" full explanations of our views and the arrangement of Seabreeze's investments -- regardless of the time of the month.
I strongly feel more transparency is better, particularly in the recent regime of heightened market volatility and given the unprecedented declines in both equities and bonds this year.
With that in mind I sent some additional comments to my investors over the weekend -- but this time I made my comments brief and on point.
To begin with, despite the market carnage and startling daily volatility, Seabreeze's investment returns are slightly positive for the year- compared to the average share price decline on the New York Stock Exchange of approximately -30%, the S&P Index's drop of -25% and the Nasdaq Index's decrease of -35%. (Past performance is no guarantee of future results.)
There are several things I am more certain of that influence my current investment strategy. I shared them with my investors on Saturday and now I share them with our subs in my Diary today:
* Lower stock prices are the friend of the rational buyer. They provide a better intermediate term upside reward vs. downside risk and sow the seeds for superior investment performance when stocks resume an upwards trajectory.
* Warren Buffett famously professed that "investors should be fearful when others are greedy and greedy when others are fearful." Fear is the oldest and strongest emotion of mankind. But it is logic of argument and analysis -- not fear or greed (the two emotions that drive markets) -- which should guide our investment process. Though times like this are challenging, being unemotional when others are losing their heads, remains an integral part of my investment methodology.
* It is my view that the historic drop in stock prices has provided an opportunity to buy great companies at good prices -- but not-yet-great companies at great prices.
* Though there are currently expanding concerns about financial stress, especially in Europe, I believe that those concerns are overblown as most financial stress indexes put too much weight on the appreciation of the U.S. dollar than actual balance sheet considerations. On the latter score, I do not see excessive conditions -- similar to previous cycles as in mortgage and finance - that suggest a systemic breakdown.
The banking industry is in great shape, with strong capital bases and well reserved for losses -- just look at this week's stellar results -- private and public companies' balance sheets are healthy and the consumer possesses excess savings and has been deleveraging for nearly two decades. Moreover, many individuals and corporations have refinanced at very low rates. While the current economic recovery is losing strength, there has been little time to accumulate credit problems.
* Though equities are growing more attractive, as noted in my Diary's commentary over the last two months, there are existing headwinds:
- Goods inflation and the prices of durables, automobiles and housing, are moderating rapidly -- but wage inflation will likely remain sticky.
- A too strong U.S. dollar and rising interest rates ("all roads lead to interest rates!") remain our biggest investment concerns. An elevated risk-free rate of return is particularly concerning. The two-year U.S. note yields about 4.5% - it is not only a strong alternative to equities but is an important part of the calculus used in valuing stocks in a dividend discount model. (DDM is a quantitative method used for predicting the price of a company's stock based on the theory that its present-day price is worth the sum of all its future dividend payments when discounted back to their present value). As such, higher interest rates diminish the value of stocks, especially high growth, Nasdaq names.
- Warren Buffett also once said "only when the tide goes out do you discover who's been swimming naked." In economic terms, the transition from too easy to much tighter monetary conditions has been a tide going out, which has revealed the incompetence and lack of quality leadership of our fiscal and monetary authorities. The monetary tide, in particular, has been "guided" by a bunch of academicians (armed with 400 PhDs) at the Federal Reserve who erroneously determined, through ex ante analysis, that inflation would be transitory - marking the single largest mistake in The Fed's 109 years of history. The Fed is now following up with another mistake, based on ex post analysis, by tightening too aggressively.
- While traders and investors remain in a quagmire of uncertainty with numerous economic and market outcomes, some of them adverse - I reminded my investors that bull markets arise from bad news (March 2009, December 2018 and April 2020) -- while bear markets are borne out of good news (late 1999/early 2000, September 2007 and December 2021).
- There is little question that the evolution of market structure from active to passive investing -- which has delivered a false sense of diversification -- has been a contributing factor to the pace of the recent market decline. Quantitative products and strategies, that generally worship at the altar of price momentum, know everything about price and very little about value. As such, they, like lower stock prices, are our allies as their role in distorting stock prices and markets provide us with attractive entry points.
A few years ago, I was invited by Warren Buffett to sit on the dais with him and his partner Charlie Munger at Berkshire Hathaway's (BRK.A) (BRK.B) Annual Meeting in Omaha, Nebraska in front of 40,000 Berkshire devotees. Warren had grown tired of the same old questions year after year. I was picked by The Oracle of Omaha to be the "Credential Bear" and my charge was to ask hard-hitting questions.
The experience was one of the thrills of my lifetime, especially since I was accompanied by my son, Dr. Noah Kass.
At the time Berkshire Hathaway had an unusually large cash position -- much like my hedge fund has had throughout most of 2022.
During lunch I sat between Microsoft's (MSFT) Bill Gates and Charlie Munger. While munching on a cheeseburger and sipping cherry Coke, Charlie confidentially told us that "it takes character to sit with all that cash and to do nothing. I didn't get to the top where I am by going after mediocre opportunities."
For reasons enumerated in my Diary and in my regular monthly commentaries to my Limited Partners, I have felt the same way -- and, taking the cue from Charlie, Seabreeze has husbanded our cash this year.
My current cash reserves position me to opportunistically take advantage of the expanding investment opportunities that may now be developing -- just as Berkshire Hathaway has recently increased the size of its equity holdings and has reduced its massive cash hoard.
(This commentary originally appeared on Real Money Pro on October 18. Click here to learn about this dynamic market information service for active traders and to receive Doug Kass's Daily Diary and columns from Paul Price, Bret Jensen and others.)