"Oh Don't Worry, We Can Spot the Next Downturn"

The title of today's newsletter is a quote from a close friend and portfolio manager in the long/short hedge fund industry. Like most hedge funds, he tries to ride momentum stocks up, and for those with bearish momentum, down. 

Every time I passionately tell him about a new and exciting investment thesis with a value oriented, defensive businesses, shockingly still available in this overvalued market, he questions why "there is no momentum." He doesn't care about cash flow, buybacks, dividends, return on capital, market share or cyclical exposure. You can offer him a fantastic business with a 20% free cash flow yield. He doesn't care. He just wants to see a stock on-the-move. If it has momentum, either up or down, then he's interested. 

The popular trend-trading style of investing can work, at least for a period of time. I'm not saying it's fundamentally flawed. But the idea that one can spot when Pets.com turns down permanently, instead of just exhibiting volatility... well that's nonsense. Impossible. Bitcoin, apps, tech, VC, crypto, cannabis, high yield, and eventually FANG stocks... They all have a ride-up that includes volatility. And then they crash. That's the nature of markets. 

The idea that one can forecast whether an overvalued asset is experiencing temporary volatility instead of a permanent redirection is just utter nonsense. You cannot predict what the equilibrium of the entire market will do. There's an inherent price-setting osmosis in the markets determined by the collective push and pull of the bulls and bears. Nobody can predict the future outcome just based on technical chart trends. 

Which is why it's so important to focus on fundamentals and solid research in this period of elevated valuations, stretched cycles, record low rates and peak margins. This is precisely what investors in the market today are NOT doing! Everyone is still chasing growth and momentum leaving phenomenal value oriented opportunities out there as David Einhorn recently lamented in his quarterly letter.

The problem today is that even if one could predict whether a market shock is temporary volatility or a permanent trend reversal, the risk of an immediate 1987 shock is increasing. The S&P 500 Ex Financials index witnessed its member companies more than double borrowings to $5 trillion over the past decade. There is a wave of corporate maturities in 2019-2021 that more than triples the maturities of 2018, and rates are rising. 

But the big behemoth metric that is not calculated in any corporate financial statement is the national debt. With rising rates on top of record debt, the future economic environment is resting on very shaky legs making the theory of trend-trading that much more impossible to succeed.

Dan Shainberg

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#RecessionResister
@DanShainberg