Kass: What to Do When the Smart Guys Lose

Learn from their mistakes, and keep investing/trading positions small.
Publish date:

This blog post originally appeared on RealMoney Silver on Jan. 7 at 8:10 a.m. EST.

We are witnessing the passing of two eras: Political change and economic change are going hand in hand. It is no coincidence.

"They said this day would never come."
-- Barack Obama

On the political stage, the initial and near-universal skepticism of the populist candidacies of Barack Obama and Mike Huckabee have been replaced by fear from the other machine -- that is, entrenched Democrat and Republican candidates who have incorporated their own brand and notion of change quicker than you can say Rumpelstiltskin.

Voters' response in Facebook after Saturday night's debate was that nearly half of both New Hampshire's Republican and Democratic voters wanted more of a discussion on the economy. Why? Because the neglected middle class has had enough and doesn't want to take it anymore.

The mantra of populism is surging with a force similar to the improbable and historical political triumph of Obama, an African-American candidate who easily carried the Iowa caucus even though only 3% of that state's population is black.

As Frank Rich wrote in Sunday's

New York Times

, "The two men

Obama and Huckabee are the youngest candidates in the entire field, the least angry and the least inclined to seek votes by saturation, bombing us with the post 9/11 arsenal of fear."

"We ride the tiger with our fingers crossed."
-- Barton Biggs

So, too, are the times a-changin' on the economic/business stage. Despite the protestations, dogma and dismissive comments regarding a recession from the


, who apparently still believe in fairytales (Goldilocks), higher commodity prices, weakening consumer spending and years of heavy borrowing has become the backdrop for economic and investment disappointment.

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I am particularly struck by the recent series of high-profile investor blunders by the "smart guys" -- namely, large corporations, entrepreneurs (especially of a real estate kind) and savvy investment and hedge fund managers -- which are proof positive how difficult 2008 to 2009 might end up being for investors.

I am not even writing about the $500 billion-plus credit derivative disaster; I am writing about plain vanilla equity investing. Jim "El Capitan" Cramer


an interesting column on this subject late last week.

Consider the following errors by smart guys:

  • In August 2007, Bank of America (BAC) - Get Reportacquired a $2 billion minority stake in Countrywide Financial (CFC) at $18 per share. The shares of Countrywide now trade at $8.
  • In late November 2007, the Abu Dhabi Investment Authority acquired $7.5 billion of Citigroup (C) - Get Report stock convertible at $37 and higher. Citigroup's shares now trade at $28.
  • During the course of the past six months, entrepreneur Joe Lewis has acquired nearly 10% of Bear Stearns (BSC) . It is not clear what his average cost is -- around $100 is a reasonable guess -- but he is believed to have a paper loss of at least $250 million. Bear Stearns shares now trade at $78.
  • Real estate developer Harry Macklowe acquired a number of trophy midtown Manhattan office properties from Equity Office Properties at the height of the market's values and before the seizure in the credit markets. An inability of rolling over the debt could crush the Macklowe real estate empire.
  • In May 2007, ESL's Ed Lampert announced that it acquired an initial stake worth about $800 million in Citigroup. At that time, the shares traded about $53. He is generally believed to have substantially added to his holdings in Citigroup since then. Again, Citigroup's shares now trade at $28.
  • Pershing Square's William Ackman acquired 10% of Target (TGT) - Get Report. Ackman first disclosed his position in July 2007, when the shares traded at about $65. Target's shares now are priced at $48. (CNBC's David Faber reported that Pershing's segregated fund committed to the Target investment experienced considerable losses over the last two months.)
  • Former SEC commissioner and now hedge fund activist Richard Breeden has raised his stake in Zale (ZLC) to almost 6 million shares -- he first filed with about 4 million shares in September 2007 -- or over 13% of outstanding common stock. SAC's Steve Cohen, the very best hedgie extant, also made a 13D filing back in September 2007. Back then, Zale shares traded in the mid-$20s; they closed at $13 on Friday.
  • Less than one month ago, Warburg Pincus acquired $1 billion of MBIA (MBI) - Get Report at $31 per share. MBIA's shares have since taken a southerly route and now stand at $17.

The above list is not all-inclusive; there are many other examples of smart guys losing their shirts. These costly mistakes should be a sign for us mortals that the going is getting tough.

For these reasons and others, I have consistently offered some rare advice in 2007 that bears repeating for 2008: Keep investing/trading positions small, as volatility and disappointment will occur with greater regularity.

A more hostile economic environment, at best, will lead to substandard stock market returns; at worst, it will lead to large losses. As I have written over the last six months, the next shoe to drop could be disintermediation (outflows) and closures in the hedge fund industry.

The passing of a political era concurrent with an economic era holds great import for investors. Don't be caught in the past, which is no longer the prologue for the future.

The smart guys (politicians and investors) are losing big. Learn from their mistakes.

At time of publication, Kass and/or his funds were short Bank of America, Countrywide Financial and Zale, although holdings can change at any time.

Doug Kass is founder and president of Seabreeze Partners Management, Inc., and the general partner and investment manager of Seabreeze Partners Short LP and Seabreeze Partners Short Offshore Fund, Ltd.