…the last bear capitulates. This is the flip side of the more commonly heard “the market doesn’t bottom until the last bull capitulates.”

Yes, this is folk wisdom. But the idea behind it is sound, I think. The implicit question behind both is where new buying/selling is going to come from to drive the market higher/lower after the final bull/bear changes his mind.

After all, once the last bear surrenders and reorients his portfolio from its previous defensive posture to offensive, where is fresh money going to come from to drive stocks higher? In the same vein, once the final bull concedes he’s been wrong and reorients to a defensive posture, where is new buying of bearish stocks going to come from?

I mention this now because the last big domestic equity bear, Morgan Stanley, just changed its view from seeing the S&P 500 falling by 15% over the next year to the index being flattish. The firm’s CIO is more precise than that, forecasting a 1.5% rise in the index over the coming 12 months.

After accurately predicting the S&P’s fall in the first ten months of 2022, MS called for continued declines in 2023. The market, as measured by the S&P, is up by close to 40% since December 2022, however, and the NASDAQ up by about 60%. Hence, I imagine, the change of heart.

Once MS and die-hard fans make portfolio shifts, and given the strong advance since October 2022, it becomes more difficult to make the case for further large market gains, I think. But sideways for a while wouldn’t be such a bad outcome. If so, stock selection rather than reading the overall market trend becomes the key to outperformance.

When I stumbled into the stock market 40+ years ago, the summit of equity portfolio manager skill and achievement was the long/short fund. Half the dollar value of holdings would be long positions, funded by an equal amount in stocks sold short. Therefore, in a-little-too-simplistic way of putting it, these funds had no net exposure to the general ups and down of markets; their performance was determined instead by the spread (+ or -) between the performance of the longs and that of the shorts. So , arguably, the fund could make money both in up and down markets.

As far as I’m aware, no one does this anymore. How so? I think it’s because, even though managing one of these funds sound hard, it’s actually much harder than that.

An example: the first portfolio I worked on as an analyst was a short portfolio. One of the first stocks I advocated shorting was Dr. Pepper, at that time a regional seller of soft drinks whose weak earnings suggested to me that it was in decline. What a disaster! The company was almost immediately taken over at a premium price, as part of what turned out to be the early days of a decades-long industry consolidation.

That taught me an essential difference between being long and being short. The mindset is completely different. On the long side, all you need is a few someone elses who think, like you, that a stock is undervalued. On the short side, there are a lot fewer professional portfolio managers. A big plus, meaning, I think, that this end of the market has less efficient pricing than the long side. However, the biggest negative, in my view, is that everyone–even owners of landfills–has to think the stock has no investment merit for the short to work out. So basically you need a Shohei Ohtani of finance, something that doesn’t come along very often.

The mechanics of shorting are simple:

–you borrow the stock from an owner, usually arranged through a broker, and very often from an institutional investor. Most big money managers have dedicated stock lending operations to do this,

–you sell the stock and get the use of the proceeds

–you pay the lender a recurring fee, that varies with the scarcity of the stock in question

–you agree to return the stock on request, meaning you have to go into the market to buy it.

the role of meme stocks

During the pandemic, traders with large online followings noted that for down-and-out stocks like Gamestop (GME) and AMC Theaters (AMC) essentially all the shares available for trading (the float) had already been borrowed and shorted. In fact, some had been shorted more than once, that is, more than all the float had been sold short. So if all those shares were called back by their owners, it would be impossible for all the people who had shorted them to comply. The stocks would go through the roof…and the shortsellers were apparently clueless. This is called a short squeeze. And GME was primed for one of epic proportions.

So Roaring Kitty and other traders lit the match. GME went from $5 to $120. Owners who had lent the stock called it back as they saw a unique chance to exit the stock at a gain. Shortsellers scrambled to buy back the stock and deliver it to the owners. On the day GME breached $120, trading volume was almost 10x the float.

Melvin Capital, the most prominent of the GME shortsellers, had to be bailed out by other hedge funds and essentially went out of business as a result of GME losses.

today’s situation

There’s some arcana involved in the calculation, but the short interest in GME was about a quarter of the float last week when Roaring Kitty tried again to trigger a short squeeze. That’s a lot, relative to the average exchange-traded stock, but still a whole lot less than back in 2020.

my thoughts

What I find the most weird about this is that in 2020 supposedly intelligent hedge fund managers either would not realize that their funds had ended up as all-or-nothing bets that these meme stocks would quietly die, or, equally bad in my view, that the risk/reward for holding them for the last dollar or two was acceptable.

When I was working, I used to call this taking off my hat as a human being and putting on my hat as an investor.

As a human being, I’m concerned about the war in the Middle East, the war in Ukraine and what seems to me to be the intentional cruelty of “conservative” politicians in denying women medical care. And then there’s the report that Donald Trump has told the heads of major international oil companies that he will scupper US efforts to combat climate change in return for a $1 billion payment, ostensibly to his campaign. Maybe the most troubling to me is the question of how the FBI knew to look for the ultra-secret documents Trump hid at Mar a Lago.

But put all that to the side.

What strikes me:

–the S&P 500 and NASDAQ are both up by 10%+ so far in 2024. That’s already a full year’s work. And we’re reaching the summer, which is usually a slow period for stocks. So I think it’s reasonable to expect that we’ll go sideways for a while

–looking at the story stocks that drove the market during the pandemic, using ARKK as a proxy for them, these speculative names appear to have bottomed 18 months ago. But they have been trading in a narrow range since then and have not participated in the overall market’s rally. For 2024 to date, for instance, ARKK is down by about 13%, meaning 20+ percentage points of underperformance vs. the major indices. At some point, maybe even today, it will be important to pick through the rubble in this corner of the market. For now, I’m not so interested, but that could easily change

–the domestic economy is increasingly trending back toward normal, as I see it. That doesn’t mean the status quo ante, though. And it doesn’t mean we’re all the way there, either.

Retail and fast food are, as usual, informative. Chipotle, which is relatively expensive, is strong. McDonalds, which is aimed at a less affluent audience, is not. Starbucks’ shows a similar pattern–higher income customers are back in force, while lower-income, once-a-day customers are not. Walmart (I recently bought a small number of shares, so I’m an owner for the first time this century) just reported strong results this morning. One reason for the earnings gains is that the company seems to be keeping more than the usual number of customers who traded down during the pandemic. Another reason, and one at least as interesting to me, is that I think management mindset may have shifted from defending the business it has already built to trying to expand it aggressively.

It seems to me that retail will continue to be a very important area for finding earnings surprise.

–Wall Street strategists seem to me to be unusually confused. My guess is that their general negativity comes from their having their roots, broadly speaking, in the bond market. Two consequences of this last: straight bonds have few defenses against higher interest rates; and because rates have been until recently in a secular downtrend since the early 1980s (meaning 40+ years!!), no one has much practical experience of how a period of rising rates unfolds

I’m going to get to tariffs in a roundabout way. What’s new, you may say.

I was reading an interview with the CEO of Intel (INTC), Pat Gelsinger, the other day. What I interpret him as saying is that one of the worst things previous management had done was to decide to give profits a short-term boost by no longer using cutting-edge ASML tools to built its newest chips and to remain with older, less sophisticated tools instead. The idea, I guess, was that no one would notice the resulting drop in quality, and that profits (therefore bonuses for top management) would be larger by the amount “saved” by using older manufacturing equipment. A win-win.

As usual, though, customers figured out pretty quickly what was going on–INTC’s chips went from being Super-fast but clunky to just the latter–and started looking for other suppliers. TSMC, which had always been a year or two behind INTC, established a technological lead that it has yet to give up.

In other words, a disaster.

This is a familiar pattern in corporate life. A newly-minted CEO has spent, say, 30 years in corporate infighting in order to get to the top–and has maybe five years to cash in big after all that work. So it’s hard, in terms of personal wealth, for the CEO to say, “We’ve coasted too long. We need a thorough product overhaul. This will mean losses for the next few years. But we’ll have reset ourselves to achieve industry dominance after that.” At worst, the CEO gets fired. At best, there are no bonuses for much of the CEO’s time at the top and the next in line gets to look like a genius and reap the rewards of restructuring.

(I should mention that I’ve been buying INTC as a value stock, on the idea that a turnaround is underway. Not my normal thing, but I think Gelsinger is on the right track and the company is getting enormous subsidies from Washington.)

The reason for my sketch of the “bad” INTC is that I see this kind of dysfunction as the story of the domestic auto companies over the past half-century.

As to the new tariff, it’s being portrayed in the press as a naked attempt by Washington to cultivate the auto worker vote in advance of the November election. While this may be true, I don’t think this is the major reason.

I think it’s because, despite 50 years of protection (or because of this), Ford and GM are still hot messes. According to Businessweek, for example, Detroit’s idea has been that a large part of its EV profits will come from subscription to manufacturer-offered services like mapping, music… But GM and Ford can’t get their own systems to work. Worse than that, Apple has given up the idea of making its own EV and is doubling down on getting its ecosystem into Detroit’s cars.

Why the tariff? I think it’s to force Chinese EV companies to make the EVs they sell in the US in the US. In other words, the same strategy Washington has used in dealing with Japanese and EU competition. Underlying it is the assumption that as companies GM and F are lost causes–but it’s political poison to say this out loud.

This morning I saw a Bloomberg report of a survey the company among users of its terminals (presumably sophisticated investors), asking people what they think is the best investment to protect their money from inflation. The #1 choice, made by close to half the respondents, was gold; #2 was large-cap NASDAQ tech stocks.

Both are very odd answers, especially for professionals. The numbers tell us why:

past ten years

CPI +32%

IBM (the biggest name of yesteryear) +7%

gold +67%

ORCL (another (former) ghost stock) +150%

S&P 500 +187%

Nasdaq +300%.

past 25 years

CPI +71%

IBM (same old, same old) +56%

ORCL (reinventing itself) +170%

S&P 500 +286%

NASDAQ +552%

gold +670%*

*Gold needs a footnote. During the 1980s, gold lost 85% of its value. The starting point for the quarter-century calculation made for this post is pretty much the lowest point of that decline. Hence, the huge gain. Looked at another way, gold has yet to achieve its $2600/oz level of early 1980, 40+ years ago.

Two other things:

–the gold peak in late 1979 coincided with a downturn in base metals. So every big miner began developing gold mines, leading to widespread overcapacity. I don’t see why the same thing can’t happen again

–there’s a terrible Hong Kong joke that I heard in the 1980s about the mandarin fleeing from Shanghai to Hong Kong after WWII with a fortune in gold and jewels sewn into his garments. He falls off the boat. A cruel way of saying that storage and transport are significant issues with precious metals and jewels.

what surprised me

Again, two things:

–why take the risk of owning a few of today’s stars rather than an index? Yes, you might pick a Nvidia or ARM. But you might also end up holding an IBM or Oracle …or even a DEC, now-defunct

–a huge percentage of finance professionals responding think that holding gold is the best hedge against inflation. How can this be? You don’t even have to know anything about the gold standard or about the mining business. Just looking at a chart shows you how risky a bet this is, even assuming you solve the storage problem.