Doug Kass is no stranger to controversy. The self-described contrarian with a calculator views the stock market objectively and unemotionally, preferring to let valuation and facts guide his bullishness or bearishness.
Kass’ dispassionate approach often puts him at loggerheads with momentum investors who, in his words, “know the price of everything but the value of nothing.”
For example, when he included a 10% rally in his annual surprises in December, many scoffed at the idea stocks could go higher in the face of worsening earnings, high inflation, and economic uncertainty.
Yet, that’s exactly what happened, and then some. The S&P 500 has marched much higher than Kass expected, and that strength has continued despite his growing concern that valuation is getting too stretched to be sustainable.
Kass’ Bearish Bet Gone Wrong (So Far)
Historically, stock market returns get harder to come by once the S&P 500’s forward price-to-earnings ratio gets above 18, like now. Toss in bond yields that are the most competitive to stocks in years, inflation, declining earnings, and economic uncertainty, and you’ve got a worrisome recipe.
Those risks were why Kass flipped the switch from bullish to bearish this summer, a decision that has again put him at odds with the momentum crowd. The S&P 500 has rallied about 9% since May 31.
In his Real Money Pro daily trading diary entry on July 28, Kass concedes, “I remain short, and wrong, as fear and doubt have left Wall Street.”
That kind of humbleness and honesty is a hallmark of any investor who has experienced multiple bull and bear market cycles — more of those in the hedge fund industry should be as candid as Kass.
Kass acknowledges that stocks can move further than anyone anticipates. Momentum can often cause periods of pain for those with a contrarian mindset.
“You are never as smart as you think you are when you are making money or as dumb as you think when losing,” wrote Kass.
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What does Kass think now?
He remains bearish, expecting stocks will eventually retrace some steps.
“Being wrongly positioned in this relentlessly advancing market is humbling and draining,” wrote Kass. “I remain negative… and incorrect in view… Fortunately, my risk management techniques have been good throughout the sharp market rise.”
As Kass suggests, controlling risk is key in any market environment.
One way Kass has done that is by opportunistically trading the S&P 500, NASDAQ 100, and individual stocks, such as Apple (AAPL) – Get Free Report and Tesla (TSLA) – Get Free Report, from the short side rather than embracing a dig-in-his-heels approach to these positions. For example, he wrote in his diary that he closed most of his Apple and Tesla trades for a loss on July 27, saying he’ll revisit them.
Stocks have made a big move up, and momentum is in the hands of the bulls. Yet, valuation continues to stretch, and Kass thinks that still makes buying blindly risky.
He may be wrong for now, but as any investor who has been in the business for decades will attest, a lot can change quickly.
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