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 Silver readers in "The Edge," his daily trading diary.
This week, Kass wrote about how to protect oneself against possible market corrections, disclosed his latest favorite long and short stocks and what Toll Brothers' conference call indicates about the state of housing.
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Protection Against a Correction
Originally published on Feb. 24 at 9:07 a.m. EST.
Yesterday's "Fast Money"
followed a tumultuous two days for Mr. Market.
The subject of the segment was how to develop a "correction protection plan."
While watching a terrific Daytona 500 race on Sunday, I got to thinking how the race was a metaphor for the stock market.
You might be surprised that a nice Jewish boy from Long Island is a fan of Nascar racing, but that is a story for another day!
I expressed the view to Simon Hobbs and the gang that the market over the next few weeks or months will likely begin to resemble this past weekend's Daytona 500 in which half the field was wiped out in three different crashes.
Going forward, I would expect more of the unpredictable in a less hospitable stock market. That lack of predictability was reflected, for example, in 20-year-old rookie driver
remarkable Daytona win only his second Nascar event. Bayne's win was comparable to a Triple-A baseball player drilling the game-winning homer in the World Series -- maybe even more unlikely.
As amazing as first-time starter Bayne's win was the changing character of the Daytona 500 race -- there were 74 lead changes, 22 different leaders (more than half the 43-car field) and a record 16 caution flags. The track had a new smooth asphalt surface installed and some other
that produced an unusual race that resembled team dancing -- one car pushing another one around in order to draft.
Similar to the Daytona race, I believe the market's smooth rise since late summer is also in jeopardy.
The question at hand for the "Fast Money" segment then was: How does an investor or trader become a winning driver like Trevor Bayne? How do we successfully navigate a market that is no longer a one-way market -- one that is more volatile and less consistent, one in which oil rises by nearly $8 a barrel in one day (and $16 a barrel in three days!) and has as many twists and turns as does the Daytona 500 race?
My Correction Protection Plan
On "Fast Money," I recommended employing four core yet simple principles to navigate an increasingly uncertain market.
Maintain above-average cash positions. Obviously, in an extended market, an investor should be more cautious than usual. Be less concerned with return on capital, and be more concerned with return of capital. Think less of lost opportunity, and be concerned more with loss of investment capital. To do this, keep an above-average cash reserve for peace of mind and for opportunistic buying during a more problematic investment backdrop.
Buy protection. Options are still cheap despite a rise in volatility this week. It is now a good idea to buy protection. If you are short, buy out-of-the-money calls; if you are long, consider buying out-of-the-money puts to hedge.
Diversify. Most investors are not as smart as Oracle of Omaha, Warren Buffett. It's a good idea to diversify along industry and sector lines. It's probably not a great idea to have more than 15% in any one S&P 500 sector (e.g., broadly speaking, technology or industrials), probably one should have no more than 10% in any individual industry or more than 5% in any one company investment.
Check your fundamentals, not the price action of stocks. Worshipping at the altar of price momentum is a profitable strategy in a bull market that moves higher on a consistent basis, but, in a two-way market that has had such a big move, is less predictable and subject to randomly changing swings in sentiment, I would avoid momentum plays (both in longs and shorts). After all, we have already seen Apple , Netflix and many other high-octane, momentum stocks reverse violently in the last week. This sort of action will become more commonplace. In other words, place your emphasis on fundamentals, not on price momentum.
Tim Seymour asked me a sector question: What should be our playbook on individual stocks? Clearly, he said, the companies leveraged to the industrial cycle had been hurt of late. I said that I would avoid industrials for now, and I suggested getting long consumer nondurables -- safe franchises with long global reaches such as
Procter & Gamble
. The stocks have underperformed, have relatively low valuations, generate large free cash flow and are defensive.
Brian Kelly asked me about my market thoughts. I responded by saying I still see a
. I continue to expect that the S&P 500 ends 2011 not materially different than it closed out year-end 2010 -- reminiscent of the flat performance in 1953 (-0.80%), 1960 (-0.75%) and 1994 (+1.10%), in which the accumulated yearly return was near zero. I ended the segment by saying that 2011 should be a great year for opportunistic and "Fast Money" traders but a poor one for the buy-and-hold crowd.
At the time of publication, Kass was long Clorox, Colgate Palmolive and Procter & Gamble.
Favorite Long and Short
Originally published on Feb. 25 at 1:15 p.m. EST.
At the time of publication, Kass was long Clorox and short iShares Russell 2000
Positive Early Signs From Toll Brothers
Originally published on Feb. 23 at 2:36 p.m. EST.
There are some good early signs in
conference call (ongoing) that residential real estate is in a modest recovery and that inventory is being slowly cleared.
This input is consistent with this morning's national housing sales
Specifically, orders (though only at 60% of the average over the last decade) are back to 2007 levels. Importantly cancellation rates, which peaked at around 36% at the cycle bottom, are now back to 6%-7%, which is the company's historic norm.
The spring selling season has started off well, with sales deposits up 15% year over year (up 9% on same-store basis).
The company reports that the Washington, D.C., to Boston corridor is very strong, especially Hoboken, N.J., Brooklyn and Manhattan.
It appears that the national housing picture is a bifurcated one, with the aforementioned regions doing well and the very weak areas (e.g., Arizona, Nevada and California) still sluggish.
Overall, pricing power is still broadly lackluster.
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.