My interview; Navy SEAL Trader at Jefferies Helped Expose Hedge Fund Scandal; Expectations, Inflection Points, Variant Perceptions, and the Herd

1) I recently did a podcast interview with Jim Fini, whom I met skiing in Jackson Hole in early March.

Over nearly an hour, we discussed a wide range of topics – including a cost-benefit analysis of COVID-19 shutdowns, investing for either a Donald Trump or Joe Biden win in November, and the life lessons in my new book due out later this year, The Art of Playing Defense. Here's the link to the podcast.

2) I'm a big fan of the Navy SEALs. A handful of them have gone rogue, resulting in some scrutiny and bad press. But overall, it's a remarkable organization filled with incredible people to whom every American owes a debt of gratitude.

To learn more from (and about) them, I let them inflict a lot of pain and suffering on me in a 62-hour program called "Leadership Under Fire," which I did in late 2014 (with 26 other members of the Young Presidents' Organization) and again in early 2015 (with Pershing Square's Bill Ackman and 22 of our friends – here's an article about it: Hedge fund and finance gods are spending their weekends doing an intense Navy SEAL training program). I'm the only person to have done the program twice...

So I read this recent Bloomberg article with great interest: Navy SEAL Trader at Jefferies Helped Expose Hedge Fund Scandal. Excerpt:

He was a Navy SEAL, before becoming a trader. Then someone messed with him.

Joe Femenia, the head of distressed-debt trading at Jefferies Financial Group (JEF), set in motion one of the most astonishing falls-from-grace to captivate the world of hedge funds. The 43-year-old is the unidentified executive outlined in court filings last week, whose taped conversation led to the swift downfall of Dan Kamensky's Marble Ridge Capital, according to people with knowledge of the matter.

The saga has laid bare the rough-and-tumble ways of distressed investing, where investors look to pull every lever in their favor.

In the industry's social hierarchy, a client who can offer or withhold significant business is usually king. Kamensky allegedly pressed that advantage by pushing Femenia to abstain from submitting a rival bid for part of bankrupt retailer Neiman Marcus. But instead, Femenia raised alarms, providing enough details on the incident to a U.S. trustee to threaten Kamensky's standing in the industry.

Boy, you know you've really messed up when you call someone and say this:

"f you're going to continue to tell them what you just told me, I'm going to jail, OK?" Kamensky said on the call, according to the document. "Because they're going to say that I abused my position as a fiduciary, which I probably did, right? Maybe I should go to jail. But I'm asking you not to put me in jail."

For more on this sordid saga, see this article: Marble Ridge 'Grave Mistake' Roils Neiman Marcus Bankruptcy.

3) Here's another excerpt from my upcoming book, The Rise and Fall of Kase Capital:

Expectations, Inflection Points, Variant Perceptions, and the Herd

Good valuation work is almost always rooted in doing accurate discounted cash flows, but here's a shortcut that often works for stocks. Just think about expectations.

Almost every stock price reflects the consensus expectations that investors have about a company's future. It's usually not hard to figure out – just read a few analyst reports.

Once you know what the expectations are, what determines whether a stock price goes up or down is whether a company's performance exceeds or underperforms those expectations.

In an ideal world, you can identify what I call an inflection point – the moment right before a stock takes off. This usually happens when a company starts beating expectations by a wide margin.

Every investor dreams of finding inflection points, but they're very difficult to identify. The good news, however, is that you don't have to have perfect timing. As John Maynard Keynes once said, "It's better to be roughly right than precisely wrong."

If you believe a company/stock is at an inflection point, then you have a variant perception.

Legendary hedge-fund manager Michael Steinhardt coined the phrase, which simply means "what do you believe that's different from the consensus view?"

It's easy to develop a variant perception – they're a dime a dozen. What's hard is being right because the market is super-efficient. That's especially true in today's investing world, in which a lot of smart people – many using supercomputers – are looking for even the tiniest mispricing.

To have a correct variant perception, you must have a unique piece of data, insight, or analysis. This is much more likely to happen if you're in your sweet spot – a country, market, or industry in which you have deep knowledge, experience, and relationships.

Developing a correct variant perception typically requires a lot of hard, focused work, often over years, even decades.

And never forget that it's very easy to be the sucker at the poker table – avoid this at all costs!

Here are examples, all discussed elsewhere in this book, of how I developed insights that led to correct variant perceptions and catching inflection points:

• Netflix (NFLX): I met twice privately with CEO Reed Hastings, for more than an hour each time, and gained an understanding of him and the company.
• Berkshire Hathaway (BRK-B): I've studied Warren Buffett, Charlie Munger, and the company deeply for more than two decades, including attending the last 21 annual meetings in Omaha.
• Lumber Liquidators (LL): I had a source who told me that Chinese suppliers were sending the company toxic, formaldehyde-drenched laminate flooring.
• McDonald's (MCD): I spoke with a franchisee who told me about the tremendous turnaround that was underway.
• CKE Restaurants: I called dozens of Hardee's restaurants to determine that the new Thickburger was a home run.
• JetBlue (JBLU): I spoke with numerous people in the company and industry as I wrote five articles about it.

In most of these cases, my variant perception was proven correct fairly quickly – in other words, I nailed the inflection point pretty well. But I've found that that tends to be the exception, not the rule. It was more than a year before Netflix and Lumber Liquidators worked, and McDonald's kept going down for three months after I first bought it. The reality is that it can sometimes take years before your variant perception is proven right.

In the meantime, you are typically bombarded by the conventional wisdom as expressed by the market. (As the French investor Jean-Marie Eveillard said, "It's much warmer inside the herd.")

When asked about the most difficult part of being an investor, Steinhardt said...

The hardest thing has been having the courage to go against the dominant wisdom of the time, to have a view that is at variance with the present consensus and bet that view.

Best regards,

Whitney