NEW YORK (RealMoneyPro) -- 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 shared some valuable Paul Tudor Joneswisdom, 12 key "big picture" factors that could weigh on markets this year and his biggest investment mistake.
Originally published on May 11 at 7:25 a.m. EDT
"There is no training -- classroom or otherwise -- that can prepare for trading the last third of a move, whether it's the end of a bull market or the end of a bear market. There's typically no logic to it; irrationality reigns supreme, and no class can teach what to do during that brief, volatile reign. The only way to learn how to trade during that last, exquisite third of a move is to do it, or, more precisely, live it." -- Paul Tudor Jones
Among Paul Tudor Jones' 13 rules, the most relevant (at least to me) are his comments above, which highlight where we might be in the market's confusing current phase.
Paul Tudor Jones is not a man to fade after decades of delivering superior investment returns. His are such good words of advice.
"Everyone is in favor of free speech. Hardly a day passes without its being extolled, but some people's idea of it is that they are free to say what they like, but if anyone else says anything back, that is an outrage." -- Winston Churchill
I continue to hold to the notion that the market is in the process of topping out -- perhaps in a major way -- and that we are in the eighth or ninth inning of the bull market advance.
As Paul Tudor Jones extols, there is often no or little logic to the last third of a bull-market or bear-market move.
Jones suggests "living it." I suggest trading around it!
I will guarantee to all of you, when historians look back at this investing period -- the bad-news-is-good-news thesis, the unparalleled role and confidence in the Federal Reserve, the buy high mentality of share buybacks, the multitude of developing malinvestments, etc. -- they will admit to how stupid investors were to have bought in.
I start the day moderately net short (via a medium position in SPY and a small position in SPY puts) in search of a price momentum change that will provide the right signals (to the downside) and take me to the Promised Land.
The Return of Price Discovery
Originally published on May 12 at 7:11 a.m. EDT
"I love the smell of napalm in the morning."
A sage observer once remarked, "Speculation is going on when someone else is making money and you and I aren't."
Speculation ("mothered" by Fed policy) has been ripe, as hot money has raised the price of financial assets even in the face of disappointing progress in the real economy, rising geopolitical risks, numerous negative macroeconomic events (particularly of a EU kind), multiple signposts of malinvestment and to a host of other factors that, in the past, have adversely impacted financial asset prices.
Valuations, particularly as expressed by CAPE or market capitalizations relative to GDP, have moved towards lofty levels.
Indeed, some have openly criticized those that were concerned as Cassandras and worrywarts -- preferring, instead, to take the position that "the data doesn't matter" (as both good and bad news were seen as good news) and to respond to positive market price behavior.
That approach has paid off handsomely as this has been the correct strategy, with averages tripling since the Generational Low.
The crowds of bulls have outsmarted the bearish remnants, as dips have been bought and even corporations have joined the celebration with a record level of share buybacks. Despite clear corporate history of buying high and selling low, financial engineering has been celebrated and has been a mainstay of the bull market over the last three years.
However, at some point -- and we are likely close -- market participants will confront, and retaliate against, the artificiality of stock and bond prices.
While no one knows (with certainty) where Mr. Market or the global economy is headed, I remain convinced that the following additional 12 key "big picture" factors could weigh on markets and on the real economy over the balance of the year and into 2016:
- Multiple and unpredictable outcomes: There have likely never been in history more numerous market and economic outcomes some of which are adverse and most of which are being ignored by market participants.
- Stuff happens: Black swans appear to be happening with greater regularity.
- Weak growth ahead: Central bankers' aggressive monetary antics have only produced subpar global economic growth.
- Borrowing from the future: Zero interest rate policy (ZIRP) has borrowed past and present sales from the future, underscoring the challenge of future economic growth.
- Unknown consequences of policy: No one knows the consequences of an extended period of ZIRP "punch bowls," often resulting in aberrant behavior and hangovers.
- Making no sense: Indeed, if there were no consequences to zero interest rate policy, interest rates could have been held at zero forever -- in the past, as well as in the future.
- Stop looking up, start looking down: Monetary overkill (in duration and in the level of interest rates) may produce the adverse consequences of malinvestment. It has resulted in the hoarding of cash and reduction in spending by the disadvantaged savings class.
- Uneven and less dependable growth: The "exclusive prosperity" of the haves (vs. the have-nots) is politically unstable, leads to more uncertainty (and unexpected outcomes) and will likely have a negative and more volatile impact on our social system, on the global economy and on our markets.
- Tom Friedman has the ticket: Our world has never been more flat, more networked and more interconnected. As such, the notion of an "oasis of prosperity" is not likely rooted in fact.
- Trouble ahead, trouble behind: Terrorism and religious radicalism (political and economic) will be more of a threat in the future than in the past.
- Treacherous technology: In a paperless (and "cloudy") world, investors and citizens are not likely as safe as the markets assume.
- Lack of coordination: Geopolitical coordination is at an all-time low and isolationism seems likely to be a mainstay in the time ahead.
No one knows for sure what factors will impact our markets. But one thing is for sure: When it occurs, a near peak in complacency will be the overriding condition and the absence of fear and doubt will be the overriding emotion.
Historically, these have been fresh conditions that have contributed to the emergence of "contagion" (in which a decline in one asset class impacts another asset class). We will likely soon recognize how shallow and illiquid our markets have become as a direct result of policymakers and in the absence of skepticism.
Safe Havens Become Unsafe
The return of price discovery may have already started in the world's fixed-income markets (as the bond vigilantes have come out of hibernation -- taking the 10-year U.S. note yield about 22 basis points higher in the last two trading days) and it is difficult to envision global equity markets unscathed.
When safe havens become unsafe (and volatile), most investors should be buckled down now in the current period of uncertainty... and complacency.
With heightened uncertainty and rising volatility, the most reasonable strategy is to reduce your portfolio's "Value at Risk."
The Worst Investment Mistake of My Life
Originally published on May 13 at 11:29 a.m. EDT
Today, I wanted to weigh in on the worst trade of my life as it, too, relates to Danaher.
Like most subscribers I am on a constant search for the next "home run" stock.
This is truly an amazing and true story. It is a story of buying a stock at $1 a share, selling it at $3.50 (on the basis of a market capitalization of about $50 million) and watching (over the last 33 years) the shares rise to reach a market cap of $62 billion, a more than 1,200 times rise in the value of the company!
I purchased a large and filing position (for about $1 a share) in DMG Inc., the predecessor firm to Danaher, back in the early 1980s when I was a general partner at Glickenhaus & Co. I bought in for several of our clients and for our general partners' account.
At that time, DMG was an almost fatally wounded REIT, with an equity capitalization of only about $15 million. It owed about $40 million to First Continental and First Chicago banks. The situation was so bad that the bank had already written off the loan!
The company's assets were a hodgepodge of junk, from an underground refrigeration facility under Kansas City to a motor home park in Albany, N.Y. Its largest asset was a strategically positioned(!) second-home community about six hours outside of Houston.
The company did have, however, a $125 million tax-loss carryforward that I valued at about $40 million or several dollars a share. (The tax laws had not yet become so restrictive about usage of these credits.) That was nearly three times the equity capitalization at that time. I thought that if the company could clean itself up by selling most of its assets, it could merge some profitable businesses into it and utilize that tax-loss carryforward.
DMG was based in Palm Beach, Fla., having moved from Boston -- a good move! My association with DMG ultimately formed the basis for my interest in moving there in 1999.
DMG's two principals were living the good life and earning close to $1 million each for running a REIT that was essentially in liquidation. The problem was that they wanted more and attempted to grant themselves (as outlined in the 1981 proxy material) a large commission on all ongoing asset sales.
After I purchased a position of nearly 10% in the stock, two other investors followed us in and filed Form 13Ds (indicating an economic interest of more than 5%). I felt that the idea of the two senior executives at DMG earning that much was appalling, given the company's position. The other investors agreed. We showed up at the annual meeting and took control of the company.
I became a member of the executive committee and the board of directors of DMG -- which was a New York Stock Exchange-listed company. We threw the two managers out of the company. We then started to liquidate the company's assets over the next few months, in an attempt to pay the banks off.
I decided to leave Glickenhaus in 1982 (and undertake my own gig). I told the two other groups that since I was no longer going to have an economic interest in DMG, and my partners at Glickenhaus had no one to continue my efforts, we were going to sell the shares. The stock had risen from our purchase price of $1.50 to about $3. The two other groups said they, too, wanted to sell, since the team that was going to spearhead the effort of managing DMG's turnaround was no longer intact.
My recollection is that we all ultimately sold to Steven and Mitchell Rales within a few months for a price of about $3.50 per share. That put a capitalization on the company of around $50 million.
The Rales brothers ultimately hired investment bankers (I believe First Boston was the company's lead) to undertake a series of large capital raises. That enabled the Rales brothers to grow the company aggressively and externally.
After they gained control, DMG's name was changed to Danaher by the controlling shareholders. The origin of Danaher goes back to the root "Dana," a Celtic word meaning "swift flowing." The story goes that Danaher's principals were on a fishing trip on the Danaher River, a tributary in Western Montana, and conceived the name change.
In the beginning, Danaher acquired Mohawk Rubber and an automotive conglomerate, Fayette Tubular Products. Further smaller acquisitions in the specialty automotive component areas followed. By the early 1990s Danaher consisted of 10 diverse but cyclical companies with a strong emphasis on automotive parts. That mix was accompanied by a very low price-to-earnings ratio. By 1996, Danaher sold Fayette Tubular Products, which marked the beginning of a move away from cyclical businesses.
The company became more acquisitive as the bull market roared and accommodated its financing needs. In 1998, Danaher purchased Pacific Scientific (motion control), Fluke Corporation (electronic test tools) and Dr. Bruno Lange (water quality instruments). In 1999, it acquired Hach Co. (water quality instruments), Atlas Copco Controls (electronic motors) and Buhler Montec Group (water quality instruments). In 2000, the company added WWG (electrical testing and calibration), API (motion control), Kollmorgen (electronic motors) and Warner Electric (motion control). The acquisition spree went on and on.
The company has stayed acquisitive. Today it owns world-class properties in five different business sectors: environmental (Hach, Chemtreat and Gilbarco Veeder-Root), testing and measurement (Fluke), dental (Kerr, Dexis), life sciences and diagnostic (Beckman Coulter, Leica) and industrial technology (Pacific Scientific, Kollmorgen).
From the humble beginning of DMG (with a market capitalization of about $15 million to $20 million), Danaher sports a market cap today of more than $62.0 billion -- by any calculation a remarkable feat. Consider that Danaher's sales stood at almost $20 billion in 2014. DMG had no sales in 1982. DHR's employees total 71,000. DMG had 36 people 33 years ago. DHR earned $2.6 billion last year. DMG had a huge loss in 1982.
All in all, the Rales team has done a truly remarkable job in transforming DMG into Danaher and managing its asset base.
Steven Rales and Mitchell Rales are still on the board of directors of the company.
Finally, here is the long term chart of Danaher (previously DMG):
It makes me sick that I sold a 10% position in Danaher.
Selling the shares was the worst investment mistake of my life.