NEW YORK (Real Money) -- 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.
This past week, Kass wrote about his view that corporate earnings are due for contraction, leading him to boost his net short position. He's also shorting Apple's (AAPL) as its iPhone product cycle winds down, and sees a spike in short-term Treasury yields on Friday's jobs data that could potentially hurt banks' net interest margins.
A Long-Awaited Contraction
Originally published on Dec. 5, 2014 at 3:15 p.m. EST.
- Some mean regression of corporate margins may lie ahead.
As I discussed Friday morning (referencing a classic episode of The Simpsons), it is now clear to me that a long-awaited contraction in corporate profit margins lies ahead.
Corporate profit margins are among the most mean-reverting economic series extant, and it was only because of unprecedented easing (and zero interest rates) coupled with continued cost-cutting (which has now ebbed) that margins continued to rise over the last two years.
As a result, corporate profits ("the lifeblood of stocks") will likely be pressured -- and might miss relative to optimistic consensus expectations.
This morning, the month-over-month hourly earnings increased by 0.4% compared with expectations of only a 0.2% rise. While the year-over-year rise in average hourly earnings is still only 2.1%, the month-over-month climb of 0.4% is startling -- not just for the Federal Reserve (and its decision-making process) but with regard to the growth in corporate profits as well.
Mr. Market's rapid advance has suggested that it might be too early to worry about wage inflation and profit margin contraction, but I believe he (and market participants) are making a mistake!
For this reason and others, I have raised my net short exposure to more than 20% today.
- I have several takes from today's jobs data.
- The yield on the short-term Treasury bills will spike now. My guess is that the yield on the 10-year U.S. note doesn't rip higher, as many expect. The yield curve might, therefore flatten a bit. (More pressure on bank industry's net interest margins?)
- The Fed will raise rates sooner than consensus expectations.
- Corporate profits, corporate margins (and the U.S. stock market) have benefited from tame wage inflation over the last five years. That benefit is now likely over as what was good for Wall Street may now be good for Main Street.
Bull markets emerge from bad news (think the Generational Low in March, 2009) and corrections. Bear markets are borne out of good news.
In other words, good news might have already been discounted in the equity markets ... and that good news may soon be construed as bad news.
Despite the conventional view that this morning's jobs report is market beneficial, I say the Don't Pass Line is where my chips lie.
- I plan to more aggressively expand my short as we move into early 2015.
Given Apple strong November-to-December share-price advance, and with the recent all-time high back in sight, the consensus view on Apple's shares is now almost universally bullish. But the areas of consensus are known to shift unbelievably quickly, as the bubbles of certainty are constantly exploding in the markets.
I took a small short position in Apple, which I have traded around.
Apple is among the most widely held stocks, and among the most admired companies, so my call drew the criticism of many -- just as my September 2012 call did. (Note: My 2012 call was followed by a near-45% drop in Apple's share price in only a few months.)
The cornerstone of my bearish case is this: While the company's current product upgrade cycle -- in the iPhone -- is quite strong, but it likely represents the last important and needle-moving phone-upgrade cycle for some time.
Nearly 70% of Apple's sales and profit are iPhone-related. But the high-end smartphone market is mature, so future sales are replacement-dependent.
With fiscal 2015 (ending September) annual sales estimates now in excess of $210 billion, Apple's past successes represent a headwind unto themselves: New and incremental products must be introduced in order to move the sales and profit needles.
At the same time, the absence of new product introductions could pressure the company's earnings and disappoint investors -- and I do not believe either the Apple Watch or Apple Pay will contribute enough to fill the late-2015-to-early 2016 gap. With Apple's shares now trading at almost 15x, as compared with 10x to 11x when the company's profit has been historically pressured, the shares could be peaking as an elongated and more lengthy replacement cycle develops in the absence of important new features.
In my recent thesis, I recognized that the risk to a short position was the likely strength of near-term sales momentum, both domestic and international, provided by the iPhone 6 and 6+. Accordingly, I have put on only a small short position in Apple, which I have traded around.
This relatively small sizing has been a good thing, as both the strength of the market's recent advance and that of Apple shares have been surprising to me. As we approach the year-end mark, that strength may continue over the near-term given the calendar, and in light of this stock's important weighting in many large hedge-fund portfolios.
However, as we move into early 2015, and as the strong near-term momentum of the current product-upgrade cycle likely peaks, I plan to more aggressively expand my Apple short.
Last evening, on Fast Money Sanford Bernstein's Toni Sacconaghi made a similar case to mine -- and a cautious one.