Q: As a manager of a short fund, do you ever find yourself actively rooting against the market or against individual stocks?
A: Nope. I don’t care whether the market goes up or down because over time, if we just pursue our process we will be fine. We have the best interests of our shareholders in mind as we make portfolio decisions. As far as individual stocks, I also don’t care whether they go up or down. The stock is nothing more than a way for us to express a bearish bet that the company is acting aggressively by, say, understating their expenses.
In this regard, we’re playing blackjack. We’re holding 19, and the dealer is showing a 6. The dealer turns over a 10 and has 16 and has to hit. He might pull a 4 or 5 and beat us, but the odds aren’t in his favor. It’s the same thing with stocks in our portfolio. The companies may turn their businesses around or the chicanery was a one-quarter aberration, but across an entire portfolio, I’ll take our odds every time.
Q: Right now, your biggest short positions are Goodyear, OpenTable and Energizer. Tell me a little bit about why these stocks look like bad news.
A: OpenTable (NASDAQ:OPEN) has aggressive revenue recognition and loose terms extended to its customers, which indicates that those customers are under duress or risk of going bankrupt. There’s also deceleration in many of the metrics we follow. Many of Open Table’s customers may be closed for business sooner rather than later.
We think Goodyear (NYSE:GT) will have a bad year. Volumes and margins are under pressure. When the top line is under pressure and you can’t pass along rising input costs to customers, your entire income statement gets squeezed. Cash flow is weak and getting worse. Debt levels are high as well. Companies with heavy leverage and experiencing secular declines in their business are going to be under a lot of pressure. We think GT is one such company.
Energizer (NYSE:ENR) is experiencing greater competition in the face of stagnant organic growth. Earnings are being managed by cutting expenses at a time when greater investment is needed, in our view, to benefit the business longer term. Instead, management is focused on short-term EPS goals. Without an acceleration of organic growth (you can only cut expenses so much), we think the bunny runs out of juice in 2012.
Q: Big picture, what do you think is the biggest risk to the market right now that could affect all stocks negatively in the months ahead?
A: I wish monetary policies weren’t being used to target asset prices. I’m not convinced people “feel wealthier” and spend more because the S&P 500 is at 1,400. People need and want jobs. Higher-paying ones, too. That makes them feel wealthy and spend more.
So all of this intervention only leads to much bigger declines when the air is let out of the balloon. I think we have several more years of tremendous volatility in the markets.
If you’re buying stocks right now, you’re very late to the party. Sentiment is extremely bullish among advisors, the market is incredibly overbought, volume is dreadful, 52-week highs have been contracting, retail investors have no insurance (as measured by inverse fund volume), etc.
So the biggest risk is that we’re going to have a much more violent downdraft than people expect. What’s holding the market up right now is very, very fragile.