Don't Lack Imagination in the Stock Market

Kodak and cult horror movies... Time will tell if it flatlines again... We're right back in 1999 again... The crowd goes wild over stock splits... The foundational skill of seeing what's not there... Don't lack imagination in the stock market...

Will Eastman Kodak flatline again?

In last week's Digest, I (Dan Ferris) likened the latest turn in the saga of the left-for-dead photo company's shift into the drug business to the Stephen King thriller Pet Sematary.

Now, I have another cult horror movie on my mind...

In the 1990 film Flatliners, a group of medical students – played by a star-studded cast of Kiefer Sutherland, Julia Roberts, William Baldwin, Oliver Platt, and Kevin Bacon – decide to use a defibrillator to create "near death" experiences. Four of the five students each temporarily stop their hearts with the defibrillator, then restart them after a few minutes.

And of course, since it's a horror film, the students' risky experiments open a door to a dark side of the afterlife... Each student ends up being emotionally terrorized by people they wronged or were wronged by in ways that become life-threatening in one of the cases.

The irony is ultrahigh... Temporarily kill yourself to deepen your experience of life, and you wind up endangering your life because you meddled with the primal forces of nature.

Likewise, Kodak meddled with forces it should have left alone...

Last Friday, we reported on a series of shady-looking stock-option grants to Kodak's (KODK) management... including some made the day before the surprising announcement that the company received a $765 million government loan, which sent its stock rocketing higher.

Members of Kodak's leadership team blatantly tried to enrich themselves...

And naturally, they didn't do it through building a sustainable, profitable business for their shareholders. Instead, they attempted to reward themselves for being connected enough in Washington to get a massive loan on the pretext that Kodak would start a drug business.

As we said last week, it stinks to high heaven of the rankest crony capitalism.

The U.S. Securities and Exchange Commission ("SEC") is investigating both the loan disclosure – which may have leaked the day before the official announcement – and the stock-option grants. That led the U.S. International Development Finance Corporation ("DFC") to withdraw the loan offer. In a post on Twitter last Friday evening, the DFC said...

Recent allegations of wrongdoing raise serious concerns. We will not proceed any further unless these allegations are cleared.

The loan is on hold until further notice.

Kodak's price action since the initial loan offer reminded me of Flatliners for obvious reasons...

The original DFC loan announcement happened on July 28. At the time, the stock traded for less than $3 per share. It peaked on July 29 at an intraday high of $60 per share.

By last Friday, shares closed at less than $15. And now, they're down to less than $9...

No wonder I called the stock "dead money" last week. It was laying lifeless on the operating table... before the DFC hit it with the paddles and the heart monitor started beeping again.

Then, the options scandal broke... the loan was put on hold... and now the bottom is dropping out of the stock. (Though, admittedly, Kodak's share price still remains much higher than the day before the announcement, when it closed at $2.62... Go figure.)

Looking at the price chart, I have to wonder if Kodak is headed back to flatline territory.

Believe it or not, I don't think the outcome is predictable... though it's hard to ignore the fact that the company never should have received the loan to begin with since it has shown no competency in pharmaceuticals. Only time will tell.

For now, members of the Kodak leadership seem to be reenacting a key Flatliners plot point...

You see, once the medical students' demons from their flatlining episode start to become aggressive in their encounters, the students must make amends to get rid of them...

One flatliner is terrorized by hallucinations of a girl he bullied in grade school. He finds her address and sincerely apologizes, ending the nightmarish visions of her getting revenge.

Another flatliner's hauntings cease only after his fiancée leaves him when she discovers his secretively videotaped encounters with other women. A third student's visions stop when she learns her father died of a drug overdose after suffering with Vietnam-induced post-traumatic stress disorder. She no longer feels any pain and guilt involved with his death.

In other words, to avoid madness or worse, the group of flatliners must understand, reconcile with, or repent for what they've done in the past.

For weeks, members of the Kodak leadership team have been haunted by the Wall Street Journal, the Non-GAAP Thoughts digital newsletter, and others (including us) for their blatant attempt to siphon government-loan money via insider trading. And now, they're trying to reconcile with the evil they committed while the company's stock was flatlined.

For example, Kodak CEO Jim Continenza said Tuesday that the company supports the DFC's decision to put the loan on hold until allegations are cleared – as if his support makes the tiniest bit of difference.

If Continenza were a Flatliners character, I doubt his half-hearted attempt would work. I suspect he'll continue to be terrorized by his demons until he ups his repentance game.

Resigning immediately and forfeiting all unearned and ill-gotten compensation should do it.

If Continenza wants to go on record supporting a decision, maybe it should be the decision to fire him – a topic that should've been broached in the Kodak boardroom by now, if it hasn't been. I doubt the DFC will proceed with the loan as long as Continenza is CEO.

While Continenza isn't even trying, Kodak board member George Karfunkel seems to at least understand that nothing less than his immortal soul is on the line...

On the same day that Continenza offered mere support of a decision he has no say in, Karfunkel donated 3 million of his 6.3 million Kodak shares to a Brooklyn, N.Y.-based nonprofit organization called Congregation Chemdas Yisroel. By the IRS's method for valuing stock gifts, the donation was worth $116 million.

Good thinking... If God can't help, nobody can.

However, given that I've participated in haunting and terrorizing Karfunkel over the past few weeks, I'm a little put out that I didn't even get an offer.

George, buddy, if you're out there, you can get rid of me for a lot less than $116 million. And while I'm not saying I'll keep haunting you in the Digest if you don't make amends, I'm not saying I won't, either.

Gabish, pal?

I'm happy that I've advised avoiding Kodak shares consistently throughout this entire episode...

It's a typical human foible to see a stock pop the way Kodak did and just instinctively hit the "buy" button. Everybody has a little Will Rogers in them. The cowboy comedian once said...

Buy some good stock, and hold it 'til it goes up, then sell it. If it don't go up, don't buy it.

It's funny because it's true... Everybody is a momentum investor in a long or steep-enough bull or bear market.

But this type of knee-jerk gambling is always deadly... Seasoned professionals never trade that kind of action. It's too insane.

In fact, for most folks, short-term trading is likely a worse idea today than normal. And that's saying a lot because it's usually a terrible idea for the vast majority of investors.

That's because we're right back in 1999 when it comes to the craziness in the markets...

Back then, stock splits were treated as highly bullish news... and a major bear market was on nobody's mind.

A stock split is when a company decides that it wants to multiply its share count by some number, thus reducing its share price proportionally. It's a simple game of market math...

For example, if a stock is selling for $100 per share and the company splits it 2-for-1, it'll have twice as many outstanding shares and the price will adjust to $50 per share. If you're holding the stock on the day of the split, you'll see your number of shares double, the company's share price fall by 50%, and your position's total value stay exactly the same.

Stock splits don't change the value of the business or the attractiveness of the stock as an investment. But that doesn't matter to pajama-clad day traders seeking reasons to buy...

The excuse for stock splits is that the increased share count boosts the supply of shares, making the stock more liquid... while also lowering the individual share price, making the stock more accessible for smaller investors.

Those arguments are hogwash...

Berkshire Hathaway's Class A shares (BRK-A) currently trade for more than $300,000 each. And yet, I promise you'll find plenty of liquidity if you have the funds and want to buy.

Plus, in the age of fractional investing on apps like Robinhood, lowering the stock price is unnecessary... Fractional shares make all stocks equally accessible to small investors. If you only invest $200 in a $500 stock, you'll just get four-tenths of a share instead of a full one.

I'll never forget an early run-in I had with a former colleague involving stock splits...

I was new to the business of publishing my investment opinions in 1999. Back then, I wanted to sell short shares of search-engine pioneer Yahoo. I thought it was one of many absurdly valued stocks set to crash horribly whenever the dot-com bubble burst.

(In hindsight, it was a terrible short at that time... But that's a topic for another Digest.)

A slightly more experienced colleague got wind of my plan. I'll never forget how he repeated over and over, "You can't short Yahoo. They're going to split the stock... they're going to split the stock..." as if he were chanting a magic spell to ward off declining share prices.

His actual intent was, "Yahoo's stock will soar after the upcoming split. You're crazy to short in front of that news." Shorting in the midst of a maniacal phase like that is a really bad idea. So ultimately, he was right... but not because his argument made much sense.

Today, it's 1999 all over again as stock splits are being treated as bullish news...

On Tuesday, electric-car maker Tesla (TSLA) announced that it will split its stock 5-for-1 on August 31. Investors loved the news... Tesla's shares are up roughly 20% since then.

Meanwhile, Apple (AAPL) will complete a 4-for-1 stock split on the same date. The iPhone maker's stock also has soared about 20% since it announced the plans to split on July 30.

Apple is less than 2% away from becoming the first company ever with a $2 trillion market cap... And it could happen just two years after it became the first $1 trillion stock in 2018.

When meaningless non-news is enough to inspire a 20% rise in a stock with a nearly $2 trillion market cap, an issue I've mentioned one or 60 times before is certainly at work...

Investors today lack imagination...

When I've said this the other 59 times, I usually credit legendary investor and author Howard Marks for the insight. We have a lot in common when it comes to this topic.

But if you won't take it from me or Marks, maybe Albert Einstein is a credible enough voice. In an October 1929 interview in the Saturday Evening Post, the famous physicist said...

Imagination is more important than knowledge. Knowledge is limited. Imagination encircles the world.

It's impossible to miss the irony of Einstein underscoring the importance of imagination... at the same time that imagination-less investors were getting wiped out in the 1929 market crash.

Some folks might argue that it takes a vivid imagination to see how Tesla, which makes around 400,000 cars per year, might be worth roughly $110 billion more than Toyota, which makes 10 million cars per year. Tesla bulls could assert that it is I who lacks imagination.

But Tesla bulls aren't exhibiting imagination... They're engaged in rationalization.

Tesla is worth $110 billion more than Toyota... because Tesla's market cap is around $300 billion and Toyota's is about $190 billion. Those are simply the current facts.

The poor fools holding Tesla's stock are taking the market's judgment as gospel. They're just following the herd and telling themselves stories to feel better about it.

That's not how it should be...

Lacking imagination in the stock market isn't about justifying what everybody else believes. It's about seeing what's not there... and imagining that it will be there one day.

It requires far more imagination to try to figure out how long it will be before Tesla will ever make as many cars as Toyota does today... or to believe that maybe Tesla will never make even 1 million cars in a year, and therefore, will never be worth its current market cap.

Seeing what's not there rivals saving money as the foundational skill for all investors...

Back in 2007, at Berkshire Hathaway's annual meeting, Warren Buffett discussed the traits that his potential successor should have. As he told the crowd of investors...

Any candidate, or candidates, should be able to "see around corners" and be "wired to detect risks" including new and unforeseen investment hazards for which the past offers no guidance.

The past offers virtually zero guidance for investors to imagine that the five stocks driving the benchmark S&P 500 Index to new highs yet again today – Apple, Microsoft, Amazon, Facebook, and Alphabet – won't be fantastic investments forever.

Investors lack as much imagination about those stocks today as they did about the top five in 2000... Microsoft, General Electric (GE), Cisco Systems (CSCO), Intel (INTC), and Walmart (WMT).

Those five stocks accounted for roughly 18% of the S&P 500's total market cap in 2000, at the peak of the dot-com bubble. (Props to Microsoft for making the list again in 2020.)

Twenty years later, only Microsoft and Walmart have eclipsed their 2000 highs out of those five stocks. And both companies took more than a decade to do so... with Walmart not exceeding its 2000 high until 2012 and Microsoft not doing so until 2016.

General Electric, Cisco, and Intel have yet to pull even with their 2000 highs. General Electric never will... You could have sold the company's shares short in 2000 and forgotten about it, right up until the present moment. It's scraping along near 29-year lows today.

Nobody imagined such an outcome in March 2000. (Well, almost nobody... Unless my memory is failing me, Porter once told me his entire equity portfolio was short GE stock for a brief period back then. And regardless of that, he has certainly been all over the story of General Electric's inevitable crash over the past two decades.)

Apple, Microsoft, Amazon, Facebook, and Alphabet account for about 21% of the S&P 500's total market cap today. That's even more than the top five stocks of the dot-com era.

In other words, investors today have even less ability than they had in 2000 (the second-most exorbitantly overvalued moment in stock market history) to imagine that the current top five stocks won't be the top five forever. But I bet Buffett's successor can imagine it.

In fact, you shouldn't just imagine that the top five stocks won't be the best performers...

You should imagine that it will be something other than stocks – or at the very least, other than the S&P 500 – that produces the biggest gains over the next decade or more.

A few years ago, fund-management firm Invesco (IVZ) produced a cool chart showing how asset returns have varied in different economic environments. Here's a little sample...

Notice how these periods last anywhere from nine to 18 years... And then, imagine how hard it was at the beginning of each of those cycles to predict the ultimate outcome.

In every case, the wise man did in the beginning what the fool did only in the end...

Nobody wanted commodities until the end of the 1970s. Nobody wanted stocks in the early 1980s... but everybody wanted them by 1999. And long-term government bonds weren't on many folks' minds at any time over the past 20 years, yet they've shined over that span.

How do you feel about stocks for the next 10 to 15 years now?

Less like they're a sure thing, I hope.

There are no sure things in the financial markets. Yet at times like these, when markets are manic, more people than ever seem to believe they know the sure thing when they see it.

With the markets, I don't do predictions... So I won't pretend to know the best-performing asset of the next decade. But a quick look in the rearview mirror suggests it's unlikely to be the S&P 500 or the five stocks pushing the index toward new all-time highs again today.

I can imagine what's making everyone feel richer and happier today not lasting forever.

Can you?

For example, what if bitcoin becomes the big winner of the next decade or two?

Can you afford not to own at least a little bitcoin today? What if it becomes a 100-bagger from its current price of about $11,000? If that were to happen, a mere 1% position would likely lead to life-changing gains, while only exposing you to a tiny amount of risk.

(By the way, if you want to invest in bitcoin and other cryptocurrencies, I can't think of a better guide than my colleague and Crypto Capital editor Eric Wade. He recently joined Porter for a "Capitalism in Crisis" event. Watch the free replay – and take advantage of an offer to get two years of Eric's research for half the normal price of one – right here.)

If it's too much to imagine bitcoin surging 100 times higher from today's price, then try it another way... Imagine what would happen if the U.S. dollar made up just 50% of global currency reserves 10 years from now, instead of the 60% it makes up today.

That takes a little less imagination, wouldn't you say? Yet it's a tremendous change and could be the kind of catalyst that sends bitcoin soaring by many times its current price.

As my friend, value investor Vitaliy Katsenelson, said in the latest episode of the Stansberry Investor Hour podcast, reserve currency status is "not a God-given right. It's something you have to continue to deserve. And we are behaving as if it is a God-given right."

Vitaliy has a great way of seeing things differently than most people...

He also talked about how too many investors think in binary terms. For these investors, everything is black and white... on or off... or good or bad. There aren't any shades of gray.

But reality is more nuanced, and change can happen incrementally... A move from 60% of global currency reserves to 50% would be a massive incremental change. It's the type that could propel gold up to $10,000 per ounce and bitcoin to much more than $100,000.

Now that I think about it, most of my chat with Vitaliy revolved around reasons to own assets like gold or bitcoin... and not stocks like Tesla. Vitaliy says the electric-car maker's stock is so expensive that its share price "discounts a temporal wormhole into the future."

It takes imagination to think about what is not there... has never happened... or rarely ever happens. But I hope after reading today's Digest, you'll look deep within yourself...

Find something in your soul that allows you to imagine where you'll be 20 years from now. And more important, imagine what you'll do with your money for the next two decades.

By doing that, you'll be able to imagine what's not there right now. That can help you avoid disaster. And you'll avoid feeling like a lot of General Electric shareholders feel today...

Much poorer, when they were absolutely certain in 2000 that they would be much richer.

Don't get left out in the cold like those folks. Don't lack imagination in the stock market.

New 52-week highs (as of 8/13/20): Emergent BioSolutions (EBS), GrowGeneration (GRWG), Green Thumb Industries (GTBIF), Home Depot (HD), Innovative Industrial Properties (IIPR), iShares U.S. Home Construction Fund (ITB), Lennar (LEN), Maxar Technologies (MAXR), Flutter Entertainment (PDYPY), Procter & Gamble (PG), Rollins (ROL), Sprott (SII), and Trulieve Cannabis (TCNNF).

A quiet day in the mailbag. What's on your mind? As always, you can share your thoughts, comments, and observations with us at feedback@stansberryresearch.com.

Good investing,

Dan Ferris
Vancouver, Washington
August 14, 2020

P.S. Before you start the weekend, I must share an important message with you...

I've never publicly talked about how I started out as an investor – and lost all but $268 of my life savings. But I'm telling the story now because I want to help other investors avoid the huge mistake I made. The way I fixed that mistake got me to where I am today... and I believe it could now lead investors to a 1,550% gain in one of the best businesses on Earth.

So for the past few weeks, I've worked with the folks in our video department to record an urgent presentation about everything. Find out what I believe you should do next right here.