Why my friend Doug Kass is bearish; Opportunity in small caps; More evidence for why the U.S. should ban TikTok; The 'Charlie Munger Manifesto'

1) In yesterday's e-mail, I laid out my arguments for why I remain "constructive" – I won't go so far as to say "bullish" – on the markets this year.

But I recognize that I could be wrong, so I do my best to keep my mind open to disconfirming information and arguments – and to share this with my readers.

To that end, below is the latest missive by my friend Doug Kass of Seabreeze Partners, which he has kindly given me permission to share in today's e-mail...

Why I Remain Bearish

There is now a near universal view – after a quantum rise in the markets (especially of a Nasdaq-kind) – that the markets are headed higher over the near term and for the full 2024 year.

However, it is important to observe how wrong the confident consensus has been in each of the last two years:

* At the end of 2021, the herd was optimistic. 2022 was a disaster in both the fixed income and equity markets.

* With such a bad experience in 2022, the consensus ended the year wildly confident but this time bearish – especially on mega tech. And that could not have been further off market as not only did the market rip higher but tech materially led the way.

* Today the consensus, following the momentum built up in the last three months, is exceedingly bullish – nary a bear can be found. This is consistent with The Divine Miss M's wonderful quote that "price has a way of changing sentiment."

Count me today, as I was at the beginning of 2023 – when I was more upbeat than most – to be outside the consensus, again. This time I am downbeat when almost everyone else is upbeat.

I see a vast array of unexpected political, geopolitical, economic, and market surprises could be on tap for [the] new year...

Let's start with the most disturbing factor, the equity risk premium...

1. Equity Risk Premium: Despite the enormity of the drop in yields, the equity risk premium is still paper thin – and, historically this is a reasonable predictor of weak markets. The move higher in stocks in 2023 was mostly a valuation reset – and the specific move in the last two months has entirely been a reset of multiples as the 4Q2023 S&P EPS projections are down 4% from the beginning of the fourth quarter and 2024 S&P EPS forecasts are down by 1% in the same timeframe.

There is, to me, a single-minded preoccupation with lower yields and disinflation. To me, yields are still high relative to the (stagnating) S&P earnings yield and relative to the lowly S&P dividend yield (at only 1.45%). The S&P dividend yield compares unfavorably to the one-year Treasury bill yielding 4.80% and a three-month Treasury note yielding 5.40% – the gap between the S&P dividend yield and Treasuries is at a multidecade wide.

In other words, a reasonable risk-free, nonvolatile, and equity-like return can be gathered in fixed income today.

2. Geopolitical: As I have cautioned, the world is no safer than it was three months ago, six months ago or one year ago. Arguably it is less safe. The Black Swans of Geopolitics are being largely ignored despite the danger being equal in my view to just before both world wars. Indeed, the similarities to 1914 and 1938 are very scary.

3. Political: Politically we are also in worse shape with an aging president leading the Democratic Party and a multiple-times-indicted ex-president likely to represent the Republican Party contributing to a toxic Washington that has never been more partisan and unequipped or unlikely to compromise in important legislative matters.

4. Deficit/Debt: On that score, the burgeoning U.S. and a $300 trillion global debt crisis are being ignored. Our nation's annual deficit and the accumulated debt load will suppress economic growth:

With global debt growth accelerating at an alarming rates, markets are rallying on expectations of lower interest rates, lower inflation, and strong economic growth, a jigsaw puzzle whose pieces fundamentally don't fit together.

Lower inflation and lower interest rates point to slowing economic growth and lower corporate profits, which are inconsistent with forecasts for new stock market highs. But a foolish consistency is the hobgoblin of little minds in the [zero interest-rate policy/quantitative-easing] era, and having crossed the Rubicon into that era, we can never cross back.

The world's debt load represents an existential threat to the global economy. That debt can never be repaid in constant dollars – it can only be addressed by defaults, inflation, and currency devaluation.

The day of reckoning for this intensifying crisis is moving closer due to the exponential nature of debt. Investors who ignore this looming threat will suffer terrible consequences in the future; those who factor it into their investment decisions will better protect themselves and even prosper. But make no mistake about it – there is no way to avoid the debt crisis. Ignoring it is not an option and is the equivalent of financial suicide for anyone who sticks his or her head in the sand.

5. Economic and Corporate Profit Growth Expectations Are Inflated and Inflation Will Remain Sticky: As it relates to a consumer-driven domestic economy, the stacked or cumulative rise of well over 20% in prices since 2020 will likely weigh on both economic and corporate profit growth over the next several years. I am less concerned about a recession this year than an extended period of market unfriendly slugflation (sluggish economic growth and sticky inflation).

6. Market Structure: The action in the last three months is proof positive that markets no longer move based on fundamental economic logic. Instead, they are driven by liquidity, flows, momentum, and an extremely short-term-oriented psychology which is reflected in the popularity of 0DTE (zero days to expiration options) that today account for more than 60% of total options trading activity daily. Macro rules markets, but not in the sense of traditional macroeconomics but the new macro-structure of markets.

Thank you, Doug! These arguments are why I characterize myself as "constructive" rather than "bullish."

2) I have been saying for quite some time that I expect a market leadership rotation away from large caps, especially tech, into smaller caps. Here's a chart that shows one reason why:

And here's an essay by Wasatch Global Investors making the argument: A New Era for Small-Caps? Five Charts That Underscore the Potential Opportunity. Excerpt:

One way to assess the attractiveness of small-cap stocks is to compare their valuations to those of large-caps. Based on that relative comparison, our view is that small-caps haven't been this attractive in more than 20 years. The following chart shows how the valuations of the two market-cap segments have compared over time.

3) Two articles came out over the holidays that capture the absolute insanity of giving a Chinese company free rein to manipulate the minds of American youth...

First, here's one from the Wall Street Journal: How TikTok Brings War Home to Your Child. Excerpt:

Imagine your 13-year-old signs up for TikTok and, while scrolling through videos, lingers on footage of explosions, rockets, and terrified families from the war in Israel and Gaza.

Your child doesn't search or follow any accounts. But just pausing on videos about the conflict leads the app to start serving up more war-related content.

That's what happened to a handful of automated accounts, or bots, that the Wall Street Journal created to understand what TikTok shows young users about the conflict. Those bots, registered as 13-year-old users, browsed TikTok's For You feed, the highly personalized, never-ending stream of content curated by the algorithm.

And as NBC News reports, a new study strongly indicates that TikTok suppresses posts that might offend the Chinese government (pro-Ukraine, the Uyghurs, Taiwan, the South China Sea, Tibet, Tiananmen Square, Hong Kong, etc.): TikTok's content on some political subjects aligns with the Chinese government, study says. Excerpt:

A new report from the Network Contagion Research Institute says that TikTok likely promotes and demotes certain topics based on the perceived preferences of the Chinese government...

The institute's researchers, who are known for previously publishing an analysis showing a rise in insurrectionist hashtags leading up to the Jan. 6 attack on the U.S. Capitol, said that they believe TikTok is likely manipulating public debate not only on China-specific topics, such as the 1989 Tiananmen Square protests and massacre, but also on strategically important topics with less direct ties to China, such as the wars in Ukraine and the Gaza Strip.

Here's the study authors' full thread, and their 18-page report is here.

This further reinforces what I've been saying for a long time: We must immediately ban TikTok until it's fully under U.S. ownership and control!

4) Charlie Munger would have turned 100 years old on Monday... and I still feel his loss every day.

Kudos to Vishal Khandelwal, who put together this collection of some of his greatest quips:

Best regards,

Whitney

P.S. I welcome your feedback – send me an e-mail by clicking here.