Kass: The Message Of The Bond Market Goes Ignored

Authored by Seabreeze Partners' Doug Kass,

  • Note and bond yields are shouting that the trajectory of global economic growth will disappoint relative to consensus expectations

  • The message of the fixed income market is currently being ignored by stock investors

"This is the business we have chosen."

- Hyman Roth, The Godfather

In some quarters - indeed, in many trading quarters these days - stock price action is the sine quo non. Stock prices, we are told, is truth and the (changing) factors contributing to those charts should be basically ignored. Many prefer "the (daily) action," or better said, seize "the good action" (these days) as determinants of their buying and selling, rather than the fundamentals.

I understand this view and respect those that capture short term trading profits based on technical indicators (price, momentum, volume, etc).

Traders, machines and algos are indeed voting machines but, intrinsic values (weighing machines) usually win out over time - though the timing is always an integral part of the decision making process.

My experience is that many traders - unless they are self styled day or several day traders (with strong selling disciplines) - often end up with what Joe Granville called "the bagholders' blues."

Many (and that's machines as well as individuals) scoff at weakening fundamentals when stocks are rising and improving fundamentals when stocks are declining - it's the nature and methodology of those beasts. (They similarly scoff at the "intelligence" of bear arguments when stocks are rising and bull markets when stocks are dropping). They condemn the prospects future (whether how positive or negative it might be) in favor of the present. Indeed, some feel spread sheets and forecasting are distractions.

While it works great for many that approach doesn't work for me - and you should not view my Diary as necessarily illustrative of someone embracing the immediate price action and momentum. Even my trades are more positioning for weeks and months rather than hours or days.

In fact, my personal experience is that the more trades I make, the worse are my trading results. This might be a mathematical certainty or just that I am not very good at delivering success with frequency in such an approach.

While others do, I won't trade a stock whose fundamentals I believe may disappoint. I won't trade a stock with an intrinsic value below the current share price (simply because it is moving higher). I won't trade a stock who has a business with poor secular prospects.

Importantly, most of my investing (and even trading) has a longer term time frame than many of the short term traders I watch and read. My investing is motivated less by price action and more by company, sector and S&P profit expectations, inflationary expectations, policy, interest rates, etc. I worship at the altar of fundamentals.

This doesn't make me better or superior in approach - it just doesn't work for me as a different strategy has been profitable to me over the last four decades. (The best investors I know effectively combine several different approaches to investing).

My approach certainly leads to looking stupid, at times, when the rubber band between fundamentals and stock prices is stretched. (But, it looks smart, when value wills out - I am thinking of recent buys - and sells - in Facebook (FB) , Goldman Sachs (GS) , Amazon (AMZN) , etc. where the cumulative gains, even over a few weeks/months, can dwarf the accumulation of shorter term trading gains).

Which brings me to today's fundamental message of the fixed income markets - which are likely being ignored and could be presaging weakening economic and profit growth relative to consensus expectations and, even (now here is a novel notion) that could lead to lower stock prices.

That message is undeniable - economic and profit growth is slowing relative to expectations as financial asset prices move uninterruptedly higher:

  • The yield on the 10 year U.S. note has dropped below 2.60% this morning. (I have long had a low 2.25% forecast for 2019) 

  • The (yield curve and) difference between 2s and 10s is down to only 14 basis points.

  • High frequency economic statistics (e.g. Cass Freight Index) continue to point to slowing domestic growth.

  • Auto sales and U.S. residential activity are clearly rolling over.

  • PMIs and other data are disappointing.

  • Fixed business investment is weakening.

  • No country is an economic island - not even the U.S. 

  • Europe is approaching recession and China is overstating its economic activity (despite an injection of massive amounts of liquidity).

Bottom Line

There are numerous strategies to deliver superior investment returns.

Some of the best investors I have known, though generally "weighting" the fundies more than price action - are effective in combining fundamental and technical approaches.

Nevertheless, my approach is fundamentally-based.

I don't believe my approach is inherently better or worse than other trading approaches (that are more technically-based).

But it is the business I have chosen.

Position: Long GS (small), FB (small), AMZN (large)