I, Baruch, have just had the worst 2 days of my investment career. My biggest short shot up 20%, argh, and my biggest overweight tanked thirty fricking five percent the very next day. As you know, Bento, I am a cheery chap most of the time, bounding out of bed every monday morning convinced that this could be the very best week of my life, why not, and ready, as an american would put it, to bite the ass off a bear. But right now I have to admit to a cold, sick, dread. My karmic cycle has clearly turned down. What else can happen to me, I wonder. Until all my money is gone, I tell myself, it can always get worse. On the occasion of the 1 year anniversary of the Bear Market, I think it is time for some reflection.
We underperforming fund managers generally have 3 distinct responses when delivering unpleasant news to our investors: 1) it’s not my fault, 2) everyone else sucks too, 3) don’t worry, it’s going to get better any moment now. I am no exception, and am going to try these out on you.
1) It’s Not My Fault. It really isn’t! Honest. I can’t complain about my big long blowup, these things will happen to us all a couple of times in our careers. As a contemporary of Spinoza put it, writing of the Amsterdam stock exchange in the 17th century:
Even if we assume that the news is good and correct (something which one can only tentatively establish from private letters), that the reports come at the right time, and that they announce the happy arrival of the ships, nevertheless an untoward event occurring subsequent to the acquisition of the news, but before the conclusion of the business may destroy this splendour and contentment. For ships can sink inside a harbour and hopes be thwarted.
In fact I don’t think my ship sank. It looks like nothing is seriously wrong with the company, what happened happened right at the end of the quarter, and smarter investors than me were surprised. When the stock settles and looks as if it has stopped going down, you’ll see me back in it.
No, what rankles is my blown up short, for I Was Right. It was Qualcomm, you see, one of the most pernicious, stock-manipulative, devious companies I follow, and I had them by the short and curlies: I know their chipset business is going bad. It’s a combination of a weak handset market, overpriced chips, overweening bossiness, annoyed customers and new, suddenly effective competition. There is no way, I announced to my colleagues, that these guys are not going to disappoint, either in the quarter or in the guidance. To make it more delicious, the stock has been on a tear, holding up in the face of the biggest handset market slowdown in years. It is the most popular long in technology. The sell side loves it, suck it all up, drinks the QCOM kool-aid. You know who you are. Once again, I was right! QCOM cut its guidance. No-one noticed, however, they were too busy buying.
What they did, no kidding, was to put in danger their core franchise, their licensing business, to avoid the embarrassment and short term share price hit a guidance cut would entail. You might not know this, Bento, but Qualcomm claims IP that allows them to charge every CDMA and 3G phone manufacturer 4.5% of the value of their handsets. They’re the biggest, most successful patent troll on the planet. There’s no cost to this, other than hiring someone to open the envelopes and take the checques to the bank, so it comes at a 99% gross margin. The rest of the business is selling overpriced CDMA and 3G chipsets. Qualcomm are rapacious, parasitical monopolists, and supremely arrogant. They are not Spinozists. The huge burden they placed on the CDMA ecosystem restrained competition and innovation, and in the standards wars of the late 1990s ensured the triumph of GSM almost everywhere in the world, despite its lower spectral efficiency. CDMA was the better technology, but Qualcomm ruined it for everyone.
Nokia, which also owns lots of 3G IP, has long objected to Qualcomm’s definition of FRAND licensing, think THEY should be the parasitical monopolists, and stopped paying them last year. QCOM sued, and a bitter 18 month legal struggle followed, Nokia arguing they should pay a much reduced rate, 2%, say, and QCOM saying they had to pay the same as everyone else. This went on until the day before a major hearing in a Delaware court was to start, coincidentally the same day QCOM was to report its 2008 Q3 results, whereupon QCOM turned around and offered a surprised Nokia basically everything they wanted. The next day they also informed Wall Street that they weren’t going to sell quite as many 3G chips as they thought they were going to, and that the 3G market wasn’t growing quite as fast as they thought. For a company which has carefully manipulated and smoothed its earnings faultlessly, beating every quarter and producing bogus “positive pre-announcements” for over 2 years now, this was pretty big news, and I, me, knew it was going to happen!
Of course, even I could not have predicted they would sell their very soul to avoid the 10-15% negative share price impact of the warning. The stock jumped 20%, as everyone had assumed the Nokia-QCOM saga would go on and on, and in the meantime all the analysts had taken out any Nokia contribution from their numbers, which they could all write back into their models again and raise their numbers (less the lower license fee, and the er, reduction in the chipset number). Oh how happy they all were! They were all on buy ratings, and had there not been a settlement they would all have had to write those unpleasant “buying opportunity” notes.
And that, dear readers, is why getting my arse kicked by Qualcomm was “not my fault”.
2) Everyone Else Sucks Too: OK, this is actually true, as well. Please note I am talking about underperformance relative to a benchmark here, not necessarily absolute performance unless I mean long short hedge funds (who also have a benchmark in any case which is zero, a nice round number). This is a very strange time, one during which it feels like 75% of active fund managers really are underperforming, and no doubt it is more. I’m not just saying that because of the brokers who try and comfort me when I mention my performance, saying, “hey buddy don’t worry you’re not alone — did you know my analyst really loves Qualcomm?” — making clients feel good about themselves is their job, and a punter with an inflated sense of his own abilities is more likely to write the big tickets.
No, I am talking about really hard anecdotal evidence, the stuff I see with my own eyes, like all the equity long short in my Beloved Swiss Employers’ hedge fund of funds dropped like 5% in June, and it is not just all the single managed funds we run (I typed “ruin”) that are under the benchmark, it is all the funds I know. And articles like this one and this one, and blog posts like this one and this one and basically at least one link in every abnormal returns roundup, and Carl Icahn and like, everything, all of this makes it fairly obvious to me that some sort of transition is happening, we are in some sort of phase shift in alpha generation where the old styles (including mine, for now) stop working.
I feel it too, somehow. The market “trades heavy”. Good news makes stocks work, as ever, which means things are not terribly bad. When stocks and markets don’t react, or begin to fall on good news, you can tell something is really wrong. But increasingly I see the stocks trend back down after that first 2 day pop. Few positive reactions persist. The payoff is asymmetric, too, for if you have just a bit of hair on your quarter, miss by a penny or cut your guidance to be prudent, woe betide you. You’re going down 15-20%. There’s a sense of disbelief in good news. Intel told everyone it was all OK, and had a great quarter, yet the stock traded like shit off it. OK we have just entered the summer doldrums. Seasonally, it is not supposed to be a great time of the year, and we are supposed to Sell in May and Go Away anyway. But June and July, I swear, were not always this bad.
There’s always a bull market somewhere in tech, yet for the life of me I cannot see it. Handsets, telco equpment, GPS devices, enterprise comms and hardware, software and IT services, semis and semi cap, all the classic tech categories SUCK. Maybe notebook PCs are OK so far, but growth is slowing there, too. There is nowhere to run to, nowhere to hide, it feels like. Everyone tried to hide in telecoms services, which then blew up too. PIty the long only tech fund manager.
So keep that in mind. It’s not just me.
3) Don’t Worry, It’s Going to Get Better Any Moment Now. Combining excuses for underperfomance 2) and 3) into the same mealy-mouthed rant yet remaining consistent was always going to be tricky, and frankly I am not going to bother. This last excuse feels very much like a lie. Yet it doesn’t stop people from trying it out on me every day.
The problem with the bull case to date is that it still exists. According to the bulls nothing really bad has happened to the US economy yet. We are not in recession. It is a classic mid-cycle slowdown. We will recover imminently, in the second half. Or in the first half of 2009. “Patient, long term investors” will benefit by buying now.
I just don’t see it. Every macro indicator I look at has turned south, apart from inflation, and we have not seen significant collapses in corporate profits. We lack any sense of crisis outside of financials. In my space, too many analysts are still in love with the same stocks (Cisco, Qualcomm, and Apple) they have always been in love with. No emerging markets have blown up (unless Iceland counts). The way the market acts feels like the weird weather you get before a storm, that heavy sense of humid oppression, odd clouds, heavy swells and interesting sunsets. My dismal performance aside, we have nothing to recover from yet.
The last major bottom, in 2002, came when everyone was too scared to buy, even when a lot of people thought they should. I was trading at the time. We didn’t even know the turn had taken place (they forgot to announce it), and major players like Andor Capital, who had made out like bandits on the short side, ran themselves into the ground thinking the recovery was just another short term dead cat bounce. The prevalence of the bull case disproves itself, just as the prevalence of the bear case will do the same when it happens. I’m not talking about those bollocks “I am a bull, I am a bear” sentiment surveys, I am talking about when the big houses cut Qualcomm, bash IBM, eviscerate Cisco, vacuum-pack Visa, and debag Google.
So to sum up, I have to think about what I can do differently, without completely abandoning my investment principles and my process. It’s OK, don’t worry too much about me. I have made relative money in bear markets before, losing far less than my benchmark. I have also run profitable long short books at times like this. I do need a bit of luck however. If you are charitably inclined you could wish me some of that.