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Musk Rap; Minsky Moment?: 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 on Apple's Beats acquisition and a potential Minsky moment.

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Nuthin' But a P/E Thang

Originally published on Thursday, May 29, at 7:22 a.m. EDT.

 

Last night, Apple  (AAPL) announced that it is paying $3.0 billion ($2.6 billion down, with a $400 million earn-out) to acquire headphone maker and music-streaming service Beats Electronics (co-founded by hip-hop artist Dr. Dre and music executive Jimmy Iovine).

We will likely be inundated (again) with views in the business media as to the merits of this transaction. Already The Wall Street Journal's lead story is this deal. 

Most talking heads will take the stage and declare this transaction to be profoundly positive or profoundly negative, as there is a tendency to develop extreme observations and make important conclusions based on every bit of corporate news -- particularly as it relates to some of our larger and higher-profiled publicly held companies.

My view of the Beats acquisition is unchanged from mid-May -- it doesn't move Apple's needle.

In the fullness of time I can think of a number of reasons why the proposed transaction is, alternatively, modestly smart and slightly additive or is modestly stupid and slightly subtractive.

The success or failure of the Beats deal will largely be a function of the ability of  two different cultures (Dre/Iovine and Apple) to integrate smoothly.

[Read: Apple Buys Beats: What Wall Streets Saying]

Secondly, it is clear that Apple has recognized that its download model is antiquated/broken and the future of music lies in streaming. As such, the success or failure of the Beats deal will be based on Apple's ability to transition into streaming. It is unclear how Dr. Dre or Jimmy Iovine will improve the company's status in that transition.

As I wrote two weeks ago:

My bottom line is that the $3.2 billion transaction is largely irrelevant due to the scale of Apple's market capitalization ($505 billion); sales ($180 billion); cash ($150 billion); earnings before interest, taxes, depreciation and amortization ($65 billion); total assets (above $200 billion); sustainable yearly gross profits ($65 billion) and earnings power; annual capital spend; and so forth.

In light of the fact that the $3.2 billion Apple will spend on Beats is earning nothing in the bank, the deal is slightly accretive.

Beats quality product image is consistent with the Apple brand.

The deal will not move Apple's needle, though. It is not, as described in this ABC coverage, a megadeal.

Nor is the transaction transformative to Apple.

The Beats acquisition is neither a change in strategy nor a statement of floundering innovation within Apple.

The Beats acquisition is a rounding error for Apple.

I can think of a number of reasons why the proposed transaction is, alternatively, modestly smart and additive, modestly stupid and subtractive or, as Randy Jackson might say, "just awright."

The acquisition did, however, take me back to the music of the early 1990s and to thoughts of the recent fall from grace of some of the high P/E multiples stocks (the beta earthquake).

[Read: How Will Teslas Stock React to S&Ps B- Junk Rating?]

Beats' co-founder Dr. Dre's first solo album (after leaving N.W.A.), The Chronic, was released in late 1992 by his company, Death Row Records. In doing so, he established his patented G-funk sound.

In collaboration with Snoop Dogg, Dre delivered his greatest hit, "Nuthin' But a 'G' Thang," on this triple-platinum album that is widely regarded as one of the most important and influential hip-hop albums of all time.

Here is the original video of the hit song that reflects hip-hop's early days of raw realism (parental advisory: explicit content).

I, "Dougie Fresh," have updated the verses in an attempt to make them relevant to today's stock market (and to the extreme levels of speculation). Let's do a sing-along that pays homage to Dr. Dre and Snoop Dogg's great hip-hop hit "Nuthin' But a 'G' Thang" and features, in 2014, Tesla's  (TSLA) Elon Musk and Netflix's  (NFLX) Reed Hastings.

"Nuthin' But a P/E Thang"
(featuring Elon Musk and Reed Hastings)

[Elon Musk]
One, two, three and to the four
Elon Musk and Reed Hastings are at the door
Ready to make an entrance in order to get our stock prices up
(Cause you know we 'bout to rip the shorts up)
Gimme the microphone first, so my stock won't bust like a bubble
Tesla and Netflix together, now you know you in trouble
Ain't nuthin' but a P/E thang, baaaaabay!
Two loc'ed out G's so we're craaaaazay!
Rising valuations is the ticket that paaaaays me!
Unfadable, so please don't try to short this
(Hell, yeah)

But, uh, back to the lecture at hand
Perfection is perfected, so I'm 'a let 'em understand
From a young G's perspective
And before me dig out a secondary, I have ta' become inventive
You never know when she could be investin' with her man,
And tradin' with her man, and at the same time earnin' with her man
Now you know I ain't wit that, lieutenant
Ain't no P/E high enough to get burnt while I'm up in it
(Yeah)
Now that's realer than real-deal Holyfield
And now all you tradas and investas know how I feel 
Well, if it's good enough to get broke off a proper chunk
I'll take a small piece of some of that funky stuff

[Elon Musk and Reed Hastings]
It's like this and like that and like this and uh
It's like that and like this and like that and uh
It's like this and like that and like this and uh
Reed, creep to the mic like a phantom

[Reed Hastings]
Well I'm freakin', and I'm creepin', and I'm streamin'
But I damn near got caught, but my subscriber base keeps increasin'
Now it's time for me to make my impression felt
So sit back, relax, and strap on your seat belt
You never been on an on-demand ride like this befo'
With a producer who can program original stuff and control the maestro
At the same time with the dope rhyme that I kick
You know, and I know, I flow some ol' funky shtick
House of Cards adds to my collection, the selection
Symbolizes that Orange Is the New Black,
If ya do, ya have no clue
O' what me and my homey Elon Musk came to do

[Elon Musk and Reed Hastings]
It's like this and like that and like this and uh
It's like that and like this and like that and uh
It's like this, and we ain't got no love for those
So jus' chill, 'til the next episode

[Elon Musk]
Fallin' back on my Tesla with a hellified gangsta lean
Gettin' funky with a gigafactory like a' old batch o' collard greens
It's the capital E, oh yes, the fresh L-O-N
M-U-S-K, E-L-O-N, ya see
Showin' a lot o' charge when it's time to wreck a mic
Pimpin' tradas and clockin' a grip like my name was Dolomite
Yeah, and it don't quit
I think they in a mood for some "S" series kit
So Reed.
(What up, dog?)

We gotta give 'em what dey want
(What's that, "S" series?)

We gotta break 'em off somethin'
(Hell yeah)

And it's gotta be bumpin' (the road to Wall Street!)

[Reed Hastings]
It's where it takes place, so I'm a ask your attention
Streamin' like a boss but I ain't lynchin'
Droppin' the funky sub numbers that's makin' the tradas mumble
When I'm on the mic, it's like the competition, they all crumble
Try to get close, and you'll get smacked
My billionaire homey Elon Musk has got my back
Never let me slip, 'cause if I slip, then I'm slippin'
But if I got Arrested Development, then you know I'm straight trippin'
And I'm a continue to put the DVD delivery down, put the mack down
And if those short-sellers talk smack, I have ta' put the smack down
Yeah, and ya don't stop
I told you I'm just like a clock when I tick and I tock
But I'm never off, always on, 'til the break dawn
N-E-T-F-L-I-X, and the road they call Wall Street
Puttin' the programming together
Like my investa Icahn, no one can do it better

[Elon Musk and Reed Hastings]
Like this, that and this and uh
It's like that and like this and like that and uh
It's like this, and we ain't got no love for those
So jus' chill, 'til the next episode.

 

At the time of publication, Kass was short TSLA.

Prepare for the Next Minsky Moment

Originally published on Wednesday, May 28, at 7:58 a.m. EDT.



 

There are times when the market gives the impression it is fading into nothingness. Volume becomes very low, trading ranges become very small, volatility becomes very low. Also, there is very little change in market levels, and day-to-day fluctuations are minimal. Looking back at history, when that happens, it is almost always a sign of a market high point.

-- Dick Arms

For over five years, the Fed and other central bankers around the world have backstopped markets with nearly free money and through quantitative easing.

The U.S. stock market has benefited from accommodative monetary policy, and the S&P 500 has tripled since the generational bottom of March 2009.

To some degree, central bankers' efforts have prevented natural price discovery in many asset classes, and their actions have caused investors to lower their guard, adopting something of a false sense of security that the market downside is limited.

Optimism, Complacency

Fueled by new highs and easy money, market observers are now growing more optimistic. Sentiment measures are at or are approaching five-year highs.

But consensus views are often notoriously wrong-footed. As an example, find me the forecaster who called for a 2.50% yield on the 10-year U.S. note and 1905 on the S&P 500 this year, and you would have found a liar.

Over history, a Minsky moment -- that is, market turmoil following an extended period of speculation and/or unsustainable growth -- sometimes occurs when complacency sets in, as stability is often the prelude to instability.

Particularly worrisome is that we might have entered one of the great bull markets in complacency, with enthusiasm rapidly building (as it typically does in a maturing and eventually vulnerable stock market cycle).

Past Is Forgotten

Regardless of the direction of the news flow of fundamental economic or corporate profit data, the markets have moved ever higher over the past few weeks.

Furthermore:

  • The VIX and other fear gauges have dropped consistently.
  • The Investors Intelligence bull/bear spread has rapidly expanded.
  • IPO activity is back.
  • M&A activity is soaring -- the number of deals worth $10 billion or more are higher than both 2000 and 2007.
  • Share repurchases have accelerated -- again, thanks to easy money and the funding of equity buybacks by bond borrowings).

All of the above conditions are back to 2007 high levels.

[Read: What Low Bond Yields Reveal About Economy]



Memories of the last down cycle (and lax lending standards) have grown faint, as evidenced by the quality (and coverage) of the leveraged buyout deals in 2014 having deteriorated, with 40% of private equity leveraged buyouts being done above 6x earnings before interest, taxes, depreciation and amortization and, again, at the highest since 2007. Investment-grade and junk spreads have plummeted, and bond yields have declined to fresh 2014 lows.

Meanwhile, in the land of technical analysis, we are experiencing divergent internal group action, relative and absolute weakness in small-caps, strength in defensive sectors, shrinking new highs, (again) anemic volume and large reactions in the growth leaders -- all of which have been historically associated with overall market weakness.

Growing Complacency

Throughout the last 12 months, the market has risen against a backdrop of very low volume, leading the way for high-frequency traders and others whom have adopted price-momentum and trend-following portfolio strategies to have an exaggerated impact on stock prices.

As mentioned previously, stock prices have risen, investors have grown increasingly complacent, and many strategists and commentators have said that market participants should be ignoring the rotten volumes.

Maybe it is different this time, but maybe it is not.

Combining the fundamentals and technicals together, a Minsky moment (hat tip to Pimco's Paul McCulley, who invented the term in reaction to the Russian financial crisis in 1998) appears to be ever closer at hand.

Renowned economist Dr. Hyman Minsky wrote that "stability begets instability ... the more stable things appear, the more dangerous the ultimate outcome will be, because people start to assume everything will be all right and end up doing stupid things."

The drop in the VIX, in particular, warrants attention and a deeper dive, as it is, to this observer, one of the better measures of complacency.

Here is what the lynx-eyed Peter Boockvar deftly wrote on May 27 about the VIX's histrionics:

As we witnessed another leg lower in the VIX last week, it has now basically gone full circle with it back near the lows seen in late 2006-early 2007, which was the calm before the you-know-what. To be exact, the VIX is a few pennies from the level last seen Feb. 26, 2007, and I believe it's instructive to look at the past cycle to see what the circumstances were the last time it was this low but also to look at other episodes of noteworthy moves in the VIX, which came close to mimicking the previous QE on/off phases.

After falling below 11 in October 2006 and staying there for a few months (it saw below 11 a few times in 2005), on Feb. 27, 2007, the VIX went from 11.2 the day prior to 18.3, as the DJIA fell 3.3% after the Shanghai Composite fell 9.2% overnight on fears that officials were going to take steps to take some of the froth out of their stock market, which had doubled over the preceding two years (and went on to double again over the next eight months). It then fell back to around 13 by April 2007, but very soon after, the Bear Stearns mortgage hedge funds blew up. And the rest is history.

On Nov. 20, 2008, the VIX peaked at a close of 81, and five days later the Fed embarked on QE1, which was further expanded in March 2009. QE1 ended on March 31, 2010, with the VIX back down to around 17. It was back to 45 two months later, as Greece became headline news, and by Aug. 27, the day Bernanke spoke in Jackson Hole telegraphing QE2, it was at 24.

QE2 began in November 2010 and ended in June 2011 with the VIX at 17. Within two months it was back to 48. Operation Twist came one month later, and the VIX steadily declined with the help of QE3 and 4 to where we stand now.

Mr. Market's Guard Down

To be sure, low volume, complacency and even technical divergences are not reliable timing tools.

Nevertheless, the rise to new all-time highs is potentially troubling when these issues are factored in with some continuing fundamental concerns -- for instance, disappointing global economic and corporate profit (and margin) growth, corporate and consumer dependency on low interest rates, the failure of QE to generate a self-sustaining expansion and so forth -- the result of which is a detachment and a blurring in the demarcation line between markets' progress and economic and profit fantasy.

We should be vigilant and aware that the U.S. stock market's risk/reward ratio is eroding with each passing rise in the S&P 500. (How much so we will only know in hindsight.)

Most investors and traders who share my concerns might begin to consider taking down portfolios to below-average exposure to the U.S. stock market now and to continue to do so into any further ramp in stock prices. More aggressive investors might ponder shorting opportunities in the days and weeks ahead. And everyone should re-read Dr. Hyman Minsky.

In summary, while it is impossible to predict when, Minsky might soon have his moment, as one of the only things we need to fear today is the lack of fear itself.

 

 

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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