Oaktree Capital's Howard Marks on Contrarian Signals & Common Sense

Howard Marks of Oaktree Capital is out with a new memo entitled, "Deja Vu All Over Again." In it, he talks about how history often repeats itself and how investors can learn and take advantage of such situations. Additionally, he focuses on "the herd" and how they're often wrong at extremes.

At the heart of the matter, Marks' latest memo centers on contrarian signals. He references "The Death of Equities," a BusinessWeek magazine article from August, 1979. At the time, the article was supposed to signal a 'tectonic shift' in investing.

The irony, of course, is that the negative article actually signaled the beginning of the greatest bull market in history. Investors who utilize contrarian signals will of course point to that as a prime example of the media highlighting extreme negative sentiment that in actuality represents an opportunity.

Marks writes,

"Likewise, in this case, according to the writer, it will take a bull market to attract investor interest and confidence. That sounds reasonable. But isn't investor interest and confidence a prerequisite for a bull market? Without it, how can a bull market get started?

The answer is that when prices are low enough, stocks can begin to rise without help from a full-fledged bull market, just as when they're high enough, stock prices can collapse under their own weight.

The bottom line here is simple, and I'm thoroughly convinced of it: Common sense isn't common. The crowd is invariably wrong at the extremes. In the investing world, everything that's intuitively obvious is questionable and everything that's important is counter-intuitive."

This kind of timeless education is exactly why we highlight Marks' memos. For more insight from the manager, be sure to read his book: The Most Important Thing.

Embedded below is the full letter from the Chairman of Oaktree Capital:



We've also posted up a bevy of hedge fund letters if you missed them: Maverick Capital's letter, Third Point's letter, and Passport Capital's letter.

Calling All Contrarians: What Signals Do You See?

Since every site on the internet seems to be spewing venom about how the government sucks, the ratings agencies suck, and the markets suck, we thought we'd head a different direction and start compiling a list of any contrarian signals out there.

First, a disclaimer: this isn't some batshit bottom-calling bonanza post. We don't engage in the X-Games sport of chainsaw juggling. This is merely an exercise similar to the one we penned back on March 8th, 2009 in our post: ranting, raving & contrarian signals that outlined just how crazy things were at the time.

This past Sunday night before markets opened to trade for the first time since the US debt downgrade, some people were exclaiming that it felt like the eve of Lehman Brothers' demise.

On Twitter, we opined that such a claim seemed ridiculous. Maybe the financial crisis made us numb to volatility, but it didn't feel nearly as extreme as 2008; not even close. Lehman was a forced deleveraging while this seems to be an unwind of QE2 excesses.

Comparisons aside, we thought it would be a prudent exercise to rationally process and analyze what we're seeing rather than spit out another article of doom that you've already read ten times. Legendary investor Jim Rogers once said, "I sell euphoria and buy panic." So today we look for signs of panic.

Current Contrarian Signals?


1. The Volatility Index (VIX) has surged from 17.5 in late July to 48 currently. The last time it was this high? Summer 2010 during the market's pullback. Since inception 25 years ago, the volatility index has only been above 44 on 9 different occasions. While it can still undoubtedly go higher (it touched 80 during the financial crisis), there has been a dramatic ramp in volatility.

2. Capitulation? This term is extremely overused. The word 'capitulation' was thrown around 396 times on CNBC last week with their octaboxes of people all talking over each other. On August 4th we tweeted that capitulation usually comes AFTER those calling for it piss themselves and reverse course. You need true panic. One example follows:

3. Hedge Fund Manager Barton Biggs: While this is only one example of 'capitulation', it does give hope to the contrarians out there. Last week $1.4 billion hedge fund Traxis Partners head Barton Biggs called stocks a "strong buy." Only a week later, he himself has capitulated (or made a smart move, depending on your view) by taking "some risk off," saying he hated to be doing so. This is merely one example of people throwing in the towel, but this is the type of behavior seen during true capitulation.

4. Retail Investors Freaking the F Out: You all probably have that one retail investor friend that doesn't pay attention to markets all that often but still wants to make money. You are their "go-to" market guy. When they start calling you wondering what the f*ck is going on, that might be a contrarian signal. When they call you saying they sold everything, that's usually a contrarian signal. Don't know about you, but we received these phone calls yesterday.

5. Bank Charges For Holding Cash: This is somewhat an outlier given it applies to accounts holding $50 million or more, but it's still worth mentioning. Instead of being invested, there is so much cash sitting around in accounts at Bank of New York Mellon that they began charging clients to hold cash in their accounts. One-month Treasury bills traded at a negative yield and indicated that investors were willing to *pay* the government to take their money.

5. ZeroHedge Crashes: The popular market website with a cult-like following crashed on Sunday night due to insane traffic as bears tried to congregate in victory and scared bulls looked for answers.

5. Dow Posts Sixth-Largest Point Loss: The market saw its worst day since the financial crisis as it tumbled 634 points. Stocks have fallen 15% in just over two weeks and such outlier events can be contrarian signals.

6. ??? What other contrarian signals (if any) are you seeing? On the flip side, what bearish confirmations are you seeing? We're looking for both sides of the argument so let us know your thoughts in the comments below.

Again, the disclaimer for those who forgot: bottom-calling is for schoolboy bitches and this post is merely surveying the carnage.

Contrarian Indicator? Magazine Cover: America's Back!

Hat tip to Paul Kedrosky for flagging this. If you're into magazine covers as contrarian indicators, then the latest cover from Newsweek should be right up your alley:

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America's Back!

S&P500: Highest Level Above Its 200-Day Moving Average In 25+ Years

Pardon the terse posts that only include a single chart lately, but they really speak for themselves. Hat tip again to the great folks over at Bespoke for generating this great research as always. They've highlighted the fact that the S&P 500 is now more than 20% above its 200 day moving average on the chart. Now, this would be all fine and dandy except for one thing: this hasn't happened in 25 years! The last time this happened? May 1983. What's even more interesting is that back then the market still continued to rally after breaching that threshold.

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This is yet another awesome fact to add to our statistics-that-make-us-cautious list (which by the way just keeps growing). After all, just a few days ago we highlighted that short interest is at the lowest level in over 2 years. Not to mention, many of the smart hedge fund minds we track on the blog have become skeptical of the rally as well, as legendary trader Paul Tudor Jones has called this a bear market rally. Additionally, other global macro firms like Clarium Capital are skeptical of the recovery.

Nevermind the fact that we are also seeing a multi-day rally of strange proportions. If the S&P were to close up 9 days in a row, that would be quite a rare occurrence. Pull up a chart of the S&P and you'll be a bit amazed. This feat has occurred a handful of times, with the most recent being in 2004 (thanks to tendollartommy for the data correction). Nothing goes up in a straight line. Well, nothing that isn't on LSD, ecstasy, bionic, turbo or whatever the kids are calling drugs these days. Then look at the rally on the chart below that preceded the current one. After going near vertical from S&P 880to 980, it still slowly chugged along up to 1010. While we don't think anyone would argue with the fact that the market is due for a pullback, it continues to defy odds and rationality. After all, the market can remain irrational longer than you can remain solvent. At the very least, we've become more cautious.

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Back on March 8th, 2009, we penned a piece entitled 'Ranting, Raving & Contrarian Signals' highlighting the ubiquitous negativity in the markets and noted that it might be a prudent time to take a contrarian viewpoint. Little did we know that our article would be published merely a few days after the market bottomed (for now at least). Now, with all the data we've been seeing, we are slowly starting to get the contrarian itch again. Maybe it's time to pen another piece, this time in the opposite direction. After all, the economy has completely recovered because Dennis Kneale said so, right?

Ranting, Raving, & Contrarian Signals

Ranting, Raving, & Contrarian Signals
A Sunday Night Satire by market folly

Let me preface this post with a bold disclaimer. I do not engage in the new ESPN X-games sport of 'bottom-calling,' which seems to be so prevalent with CNBC guests these days. Hell, even if this in actuality was 100% 'the bottom,' I wouldn't even bother staking that claim for fear of being mocked on YouTube for years to come. So, do I think this is even remotely close to the bottom? I really don't even give a damn. Is this the bottom? To that question I'll simply refer you to IsThisTheBottom.com and they probably have an answer for you. Point being, we're not getting all hopped up on 8balls, scoobydoo's, or whatever the kids are into these days and rushing out to buy stocks. After all, you only need to take a swig of KoolAid to realize that everything is just dandy! (Graphic courtesy of TraderMark). But, we did recently encounter something that made us sit down and go 'hmm.'

Here's the ultimate crux of the matter: market timing is a b*tch. It has been and always will be. Anyone who tells you 5 or 10 years from now that they "nailed that bottom" of this de-cession/recession-pression/Roubini-thon is either a liar, on acid, or possibly named Jim Cramer. No one is that good. And, if they are... they're more lucky than anything. In fact, I'd be willing to wager that the same person ballsy enough to claim they "nailed that bottom" is probably the same type of person that woos your mother (yes, your dearest mother), takes her out for a nice seafood dinner, and then never calls her again. That same person also probably enjoys going to Seaworld and taking their pants off. (Ron Burgundy: Anchorman, anyone?)

Don't just do something because someone told you to. As Jon Stewart of the Daily Show put it so brutally, "Wow, if I had only followed CNBC's advice, I'd have a million dollars today... provided I'd started with a hundred million dollars!" Instead, I'd simply recommend you take The Wall Street Journal up on their massive discount offer and sit back, relax, and read about the world's implosion. At least that way you can get some amount of news and facts, rather than asinine opinions from eight different narcs in an 'octabox' on television all yelling at each other at the exact... same... time.

If you've been reading this blog for a while, you've known I've been pretty bearish on a macro level and on the economy in general. You also know that I've been short... heavily. But, today, in the midst of this multi-year recession, I had a contrarian moment (shocking, I know). Let me walk you through my epiphany. I'm sitting here reading through my RSS feed when I was confronted with literally post after post of just sheer death and despair. Buffett and other market pundits say 'buy when there's blood in the streets.' Well, they should know, considering how they got their face ripped off and are sitting on the corner bleeding profusely, hurling obscenities the government's way. And, just from my reading, I would say there is definitely blood in the streets and we are damn near the apocalypse. Let me walk you through the post after post sequence I literally have just read. I'm not even kidding here.

1. "Gold bullion trading on ebay increased 95% from the same time a year ago."
   
2. "The S&P500 had its worst start to a year ever in its history."
3. "Unemployment hits 25 year high."
   
4. "Kyle Bass of hedge fund Hayman Capital predicting massive sovereign defaults."
   
5. "Dr. Doom." "Doom here, doom over there." "The doom bunker."
6. "3 prominent short-sellers have been covering shorts and see less opportunity on the short side. Some are getting constructively long and one has even called a bottom."
7. "I'm short AAPL." "I just shorted some AAPL last week." "My AAPL short is printing me money."
8. "Gun sales at new highs."
   

Ok, let's recap here for a second. First, people are buying gold on ebay... ebay. They're so desperate and are hunting for bricks and coins of gold as if they're playing Super Mario Brothers. Now, don't get me wrong. A lot of very smart people have been buying gold over the past few months for various reasons. But, still. When the greater public is out en masse bidding on gold on ebay, it makes me wonder if we're all about to die.

Secondly and thirdly, the S&P is off to its worst start to a year... EVER. Period. End of. That's nuts. Unemployment is the worst many people have seen in their lifetime. Things just keep getting deeper.

Fourthly, Sovereign defaults sound fun, right? No big deal, just the end of the civilized world and the finance as we know it. Pretty low on the pessimism scale.

Fifth, Nouriel Roubini. Don't even get me started. Look up 'doom' in the dictionary and his picture has now been inserted.

Sixth, well-known bears who stop ravaging campsites and suddenly cease the desire to eat honey and fish scare me.

Next: Everyone is shorting Apple (AAPL). Can you believe that? The nerve! I look back the past few years and think about how this stock was a godsend. Everybody and their dog owned it. Literally, people were putting shares in their dog's name and getting stock certificates printed up with "Fufu," "Sparky," and "Thrash" on them. If you didn't have it on your books, no one was investing with you. So, now, for people to actually be shorting it? The nerve! Things must really be bad out there! Seriously though, think about it. When is the last time you knew this many people short this name. Maybe it's just me, but I cannot even recall such a time.

Lastly, gun sales are off the charts. People are buying firearms and ammo as if they've got a Civil War going on in their living room. Smith & Wesson (SWHC) is all of a sudden the new Crocs (CROX)... their products are all the rage! Sure, some of this frenzy can be attributed to worry of Obama's stance on guns. But, at the same time, when you hear about money managers' clients pulling out large sums of money from their accounts solely to buy firearms, ammo, and canned goods... it makes you wonder. Either people are vastly overreacting or we really are headed for the apocalypse.

Again, I want to reiterate that I have been and am pretty bearish on a macro level. Things are bad out there and could very well get worse. Yet, for the very first time in all of this, I was finally given a reason to pause and evaluate just how ridiculous things are right now. After all, markets are forward looking mechanisms. Its documented that in recessions, markets bottom before unemployment peaks. Markets bottom before things reach their absolute worst. And right now, its a clusterf*ck out there. Here's some examples:

Warren Buffett has lost two legs and an arm. This sort of thing would only happen to him if we found ourselves in the ninth circle of hell. He's perceived as an investing God amongst men, right? Nope. Apparently we're right in the middle of Dante's Inferno.

Practically every major financial institution out there has been chopped down to some degree.

The other day, my friend who has never invested a dollar in his life and knows literally jacksh*t about markets wanted me to help him invest a ton of his money in, "these cool things in the stock market he heard about that make triple the money when the market goes down!!!" (i.e. triple inverse ETFs). I told him to go punch a shark in the face and try to swim away. The experiences would probably be pretty similar. Sure, my friend could possibly end up like that one guy who actually got away with punching a shark in the face, but the odds are against him.

A website called fmylife.com even popped up where people list one liners about how f*cked their life is right now. (That one isn't necessarily related to all this and is more-so just funny than anything).

Donald Trump is filing for bankruptcy... again. Ok, that was a bad example. But, I think you get the point.

Literally just wave, after wave, after wave of pessimism. Things are getting morbid out there right now. The economy is getting thrashed and unemployment is skyrocketing. (That doesn't mean it won't get even higher though). The point is, that this is constructive. This is just a necessary part of getting out of this big mess, as outlined in the stages of a bear market. Its most likely still going to get worse before it gets better. But, for the first time in all of this, I feel as if I just had a contrarian epiphany and wanted to share my experience. I'm not acting on it because like I said earlier, I'm not ESPN X-games material. Not to mention, I use the charts as one of many tools in my investment arsenal to gauge market action. And, right now, they're telling me that I'd be trying to catch falling knives. But, I guess that's what a contrarian is after all, right? They buy when literally no one else in the world wants to.

All I can really say is to stick to what you know. You know what you're comfortable with in regards to your risk tolerance, investment timeframe, etc. Take everything you hear with a grain of salt. Hell, you should even take this article with a grain of salt too. Do us all a favor, don't try to call a bottom. The market will bottom once everyone stops trying to call one. Don't act like you can time your buys perfectly, because you can't. I know it sounds like a cool story to be able to tell your grandchildren when you're 80 years old. But, think about it. When, as a child, your grandparents told you about how they walked 10 miles to school in 30 feet of snow in negative 12 degree weather, you didn't really give a damn. Decades from now, your grandkids won't care about your gunslinging, 'bottom calling' badassedness either. So, quit while you're ahead (or way behind).

Yes, things are bad. Yes, things can get worse. Pessimism is high and all of this undoubtedly means something; but what, we're not entirely sure. In the end, all we're trying to say is that this is solid progress in the bear market cycle. Now we just have to hope that this isn't actually the end of the modern world.