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Ukraine Situation; Bonds; Market Weakness: Best of Kass

NEW YORK (TheStreet) -- Doug Kass of Seabreeze Partners is known for his accurate stock market calls and keen insights into the economy, which he shares with RealMoney Pro readers in his daily trading diary.

Among the posts this past week were items about Ukraine, shorting bonds and weakness in the markets.

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Ukraine Situation Will Pass
Originally published on Friday, March 14, at 7:39 a.m. EDT.

Similar to many of the previous international crises, the Ukraine situation will likely pass, should not dent worldwide economic growth and will not be a material risk to the capital markets.

While Russia has clearly violated international law (raising the ire of the world community) and the Ukraine/Russia issue is a near-term challenge to risk assets (and our relationship with Russia), below is a list of reasons why the impact will be transitory:

  • Crimea has already been annexed by Russia. Sunday's referendum will give formal approval to something already done. (Note: Russia has always thought of Crimea as part of Russia. Thus annexation is not seen by Russians as an expansionary move but rather to defend access to the port on the Black Sea).
  • Any sanctions (asset freezing, visa restrictions, etc.) by Europe or the U.S. against Russia is toothless.
  • Russia is not likely to annex other parts of the Ukraine, as the country is financially unstable and Russia can't afford to prop up the rest of Ukraine. Moreover, a further incursion into other parts of the Ukraine would bring more substantive sanctions.
  • The referendum could be ratified on Sunday, but Russia might effect a "soft annexation" that permits Crimea integration with Kiev.

Short Bonds for the Win
Originally published on Friday, March 14, at 7:27 a.m. EDT.

If one believes that second-quarter U.S. real GDP growth will rebound from the weather-induced weakness of the first quarter, the single best investment over the next few months might be found in shorting the U.S. bond market.

As I outlined in my Kellogg School (Northwestern University) lecture two years ago and again in my Value Investing Congress presentation a few weeks later, the yield on the 10-year U.S. note (currently at 2.65%) typically trades at 80% and 100% of nominal U.S. GDP growth (real growth plus inflation).

If we assume optimistically that the domestic economy achieves 3% real GDP growth in second quarter 2014 and then add 1.5% inflation to that, nominal GDP growth could be trending at approximately 4.5% in the coming months. At 80% of the 4.5% growth, the normalized 10-year yield would be 3.6% (nearly 100 basis points above the current yield). At 100% of the 4.5% growth the normalized, 10-year yield would be 4.5% (185 basis points above the current yield).

If we assume less optimistically that the domestic economy achieves only 2.5% real GDP growth in second quarter 2014 and add 1.5% inflation, nominal GDP growth could still be trending at about 4% in the second quarter. At 80% of the 4% growth, the normalized 10-year yield would be 3.2%, and at 100% of the 4% growth, the yield on the 10-year note would be 4% -- both still comfortably above current yields.

Yesterday's flight to safety (and drop in yields) provided me with an opportunity to meaningfully raise my short bond exposure.

At the time of original publication, Kass was long TBT and short TLT.


Risk Happens Fast, but Opportunities Will Emerge
Originally published on Wednesday, March 12, at 9:45 a.m. EDT.

Finally Mr. Market is beginning to show signs of aging. 

Monday and Tuesday represented the first back-to-back market decline in weeks, and the S&P 500 has sustained further selling so far this morning.

There have been clear-cut signs of loss of share price and impetus in certain leading market sectors, while momentum in corporate profit and sales growth has been slowing. Moreover, the short-selling community has been shattered and worn out, and now officially represents -- like the dodo bird -- an endangered species. Many hedge funds have totally abandoned the notion of hedging. Even some of the most stalwart bears -- like my friend/buddy/pal Bill Fleckenstein -- were reluctant to short.

Perhaps the proximate cause of this week's weakness was geopolitical, involving the Ukraine crisis -- an unexpected event that was outside the radar screens of most investors only two months ago. 

Or perhaps, as I observed last week in the Russell 2000's 3% move in one day, coupled with parabolic moves in a host of speculative stocks, there was a classic blow-off top. 

Regardless of the reasons, many of the sign posts of a concern and downturn have been posted in my Diary.

Though uncertainty has increased, and the market's near-term picture might be problematic, it is not likely the end of the world -- and not necessarily the end of the bull market of the last five years. In fact, Jim "El Capitan" Cramer made a solid point on Mad Money last night -- that there is a silver lining to the evaporation of froth that has occurred in certain speculative segments and offerings this week. 

For some time, prices of many equities have failed to meet my investment criteria, and the reward vs. risk scenario has been unfavorable. (Note: I start the day in market-neutral mode.) 

I am hopeful that the current down spell unearths attractive investment opportunities.

One such potentially attractive investment is Bon-Ton Stores  (BONT)

Bon Ton Stores is a retailer based in York, Penn. The company operates 270 department stores, principally in the Midwest and Northeast. It offers brand-name fashion apparel and accessories for women, men and children, as well as cosmetics, home furnishings, footwear and other goods. Bon Ton operates under Bon-Ton, Bergner's, Boston Store, Carson's, Elder-Beerman, Herberger's, and Younkers nameplates. 

Yesterday Bon Ton Stores' shares sold off by 10%, reflecting the departure of company CEO Brendan Hoffman (for personal reasons). The decline was not due to the unexpected drop in results, as most of its stores are in areas of the country that were exposed to the bitter weather over the last two months.

I have initiated a buy of Bon Ton at $9.85 per share. 

I will have a more extensive analysis on Bon Ton early next week, but the following factors attract me to this name: 

  • The departure of the company's CEO likely occurred because of his desire to return to his family in New York. There was nothing untoward about the announcement.
  • Given Bon Ton's store locations, the disappointing results announced yesterday should not come as a surprise.
  • Bon Ton's shares now possess an attractive reward-risk ratio given yesterday's 10% share-price drop. 
  • While Bon Ton is debt-laden, the shares trade at only about 4x earnings before interest, taxes, depreciation and amortization, and the company is generating free cash flow. Importantly, the company has mentioned inventories well in the recent sales downturn.
  • Thomas Grumbacher, the company's chairman, is 75 years old and owns nearly 900,000 shares. Given his age and the recent management announcement, he might be incented to look at exit strategies in the period ahead.
  • I value Bon Ton at around $15 to $16 in a private transaction -- about 50% higher than Tuesday's close of $9.80 -- which I consider likely in 2014. Given's Bon Ton's geography, Dillard's  (DDS) is the most obvious buyer of the company.

At the time of original publication, Kass was long BONT and TZA.

Doug Kass is the president of Seabreeze Partners Management Inc. Under no circumstances does this information represent a recommendation to buy, sell or hold any security.

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