World
All investors need a worldview. Here’s mine and how to think about developing your own
DUK Editor TeamFebruary 27, 2023
I presented the following at the first-ever Investing Club “Annual Meeting,” held in person in New York City on Saturday and simultaneously live-streamed. Here’s the full video replay . I don’t like mysteries. I like to solve them. The first thing you must always do before you buy a single stock is to figure out your worldview. All investors need a worldview I learned this worldview concept right when I left Goldman Sachs (GS) and moved to Michael Steinhardt’s office in midtown Manhattan in the inauspicious year of 1987, the year of the stock market crash that became known as Black Monday. Michael, an irascible sort, is a one-of-a-kind genius at running money. He took me in as a favor to a friend and seeded me with capital. It was a tremendous honor as he was such a pioneer in running big money, the first person to run billions of dollars long before anyone else. I don’t know why, maybe because he thought I was green but teachable, or at least courteous to people in the office, he agreed to review my work once a week. Mind you, I thought I knew what I was doing when I was picking stocks for people at Goldman Sachs in private wealth management. I had made a lot of money for clients and a ton of money for myself, enough to leave the firm and start my own hedge fund. But I yearned to learn from one of the original hedge fund greats. He picked Thursday nights to review my work, or at least his assistant told me to be there Thursday nights. But he blew me off without even a wave the first two Thursdays, just a shrug on the way out the door – guess he had nothing for me. It was too bad for him, I told myself then because I had a hot hand and some really good ideas. I was anxious to let him know I wasn’t wasting his office space. Maybe the third time was a charm because Michael let me in on a Thursday night at about 6 p.m., and he said, “Tell me what to do with the money I so generously donated to you.” I started out by saying, “OK, the stock is Toll Brothers (TOL). It’s a tiny Philadelphia homebuilder that I think is going to go regional and then national and be one of the great investments for the next generation.” He asked me if I had anything written on it. I said I sure did. He said to give it to him. I thought I might have won him over Jerry Maguire style. I waited as he looked over the first page and then the second and then he looked up with a pixyish smile — first one I had seen this man ever surrender. He threw my work right at my face. Direct hit. He told me to immediately get the hell out of his office. He said I didn’t have a clue of what I was doing, had no right to be a money manager, and was an embarrassment to Goldman Sachs and whatever the hell other rock I might have climbed out from under. I ran out of there but quick — and, in a real twist of good fate, right into the arms of Karen Backfisch, a trader on the desk. She had seen me in the hall a couple of times and could see I was totally distraught – pulling out what hair I still had. She told me to sit down and explain what happened. If there was any Jerry Maguire that night it was Karen who “had me at hello.” The point of this story, though, isn’t that we subsequently went out for several years and ultimately got married. Nor is it an all’s well that ends well story, as Karen and I divorced 20 years later. The point of the story was that I was a total knucklehead walking into the office of any prominent portfolio manager without a worldview that determined which stocks I would own. You can’t build a portfolio, she said, unless you know what you think will happen. A worldview is what infuses all your judgments about individual stocks. Without one, you are just wasting your money. Better to play the ponies that ran behind her folks’ house at the Belmont racetrack. I had only heard that word worldview in one other venue and that was in the seven courses on Communism that I took as a Harvard undergrad. Here, I was learning on the fly, that a worldview is what matters most at the pinnacle of capitalism, a Wall Street hedge fund. Now, Karen and I have subsequently become amicable after a really hard time. I am also fortunate enough to have met Lisa. We have long since married with four kids — two mine, two hers. That’s a different kind of happily ever after story. However, what Karen said that night was totally true. You cannot pick any stock, let alone Toll Brothers, a homebuilder, without having an outlook. You need to know what you think will happen and then you can insert stocks into that worldview. Sure, there can be short-term fluctuations, and challenges out of left field – a Ukraine, a debt default scare, a Taiwan concern. But if you have a worldview and a stock goes against you that fits into that worldview and you haven’t changed that view, then you just buy more. Yes, it’s as simple as that, hence why we have our number rating system of downgrades and upgrades versus just throwing out stocks at a moment’s notice as I hear so often on television. That drives me crazy. Sometimes I want to throw the equivalent of that Toll Brothers report right at the screen when I hear the 25-minute certainty or the diametrically opposed view from the day before. Of course, it doesn’t matter. You can only control what you do. It doesn’t matter that the stock of Toll Brothers ultimately went from $3 per share back then to $58 now. Without a worldview, I might have bought and sold it terribly dozens of times. Here’s my current worldview So, what is my worldview now? What backdrop are we using to pick the stocks for my Charitable Trust, the holdings that make up the Club portfolio? I want to do two things at once: I want to present you my view and then show you how I got there so you can try out these same concepts for your own. Remember, my view may not be yours, but you will certainly know how I arrived at it. What I am going to give you is something that is supposed to bend but not break over the next six to nine months. I don’t have a crystal ball, and I hesitate to think that I can be so thoughtless as to say, “You know what, I changed my mind the other day about my view, but I am keeping my stocks.” I do change my mind if the facts change dramatically. I did for example, go totally into cash the day before the 1987 crash because of a feel, one that’s hard to describe but had to do with a total lack of anyone buying anything for two weeks straight going into that crash. That foretold everything. I wasn’t doing this project then but sometimes there is just plain instinct at play and that’s not what I am talking about now. We are not looking at that kind of dire situation because that crash was caused by mechanical failure of the entire stock market. The rules have changed, and they have kept that from repeating. Nor do I think that we are in some bearish horrendous nightmare like the financial crisis from 2007 to 2009, when I unhesitatingly told people to sell everything if they might need that money over the next five years. This is an emotional business. We just had the worst week of the year on Wall Street after a stellar start to the new year. Everybody hates the market that I know of — worried that the 2022 mess might happen all over again. That’s not my worldview. That’s just an observation. You don’t arrive at your worldview by fright or despair. You arrive at it clinically and with a sense of history, suffused with the knowledge in, my case, of being able to talk to pretty much any CEO I want to. I don’t talk to other money managers. I used to do a lot of that when I ran money professionally, but I long ago stopped it because of a belief that I am often either not getting the truth or I am being used to help someone liquidate a position. I don’t even talk to many research analysts. I don’t want to be influenced by them. Far better to just ignore all of them. They won’t be there when things go awry. You will be. Don’t hold their bag. You will have enough concerns, so don’t count on them to help you. What do I see? Right now, we are picking the vast majority of stocks, except special situations, with the idea that the Federal Reserve needs to be taken at its word: Chairman Jerome “Jay” Powell has made some mistakes, a doozy of one four years ago when he tightened too hard, or two years ago when he didn’t tighten fast or hard enough. I have no desire to rehash history. Everyone in this room knows I like Jay, glad I don’t have his job, and understands that the single worst thing he could do is to not stop inflation because inflation has an inordinately negative impact on savers, especially lower-income savers and that’s who he most cares about. He helps everybody, too, because all of us blanch at least once a day when we see or hear some price on a menu, at the supermarket register, or at the mall. I think this view, which Jay cares and is most likely going to get it right, is fundamental to my worldview. If I thought he were a clown or a monster or a person totally lacking in rigor – as so many cavalier people who come on CNBC seem to believe – I would not have the same worldview. What the yield curve says Let’s dig deeper. Money managers of all kinds are always talking about the yield curve in the bond market Remember, bond yields move inversely to bond prices. Right now, it shows that if you own a 10-year Treasury , you are going to get, using round numbers, about a 4% yield. If you want to own a 1-year Treasury you get about 5%. That’s called an inverted yield curve meaning that investors, huge investors, think that the Fed is going to reach a level with policy interest rates very quickly that will be so onerous that we will see a rather quick undoing of these rate hikes, to the point that we will look great holding a 10-year piece of paper that yields 4%. I say, wait a second. Think about it. Think of all the risk there is if you hold money in an instrument for 10 years versus one year. I think that’s an absurd tradeoff and those who are making it, those who own 10-year Treasurys, are sorely ill-advised. Rather than reach a conclusion that the 10-year is never wrong, I say, “Do your own thinking.” My thinking is the Fed is going to keep on tightening until it’s obvious that food, wage and housing inflation – all three of them – are banished from our purview. That process is going to be unfriendly to the 10-year Treasury in both time and price. If you have that opinion, and not some guessing game about where he will take rates, you are on very solid ground to make coherent decisions about stocks. I know that when I interviewed Jamie Dimon, the CEO of JPMorgan , the other day in West Philadelphia, I played the parlor game of how high will the Fed take the policy rates. Jamie was gracious enough to give us his view, worth a great deal to me, that Powell could take rates to 6%. That was good headline, and I knew it. What I told Jamie when the cameras weren’t rolling was that I thought Jay Powell was doing a darned good job trying to figure out how to stop rates from going too high, but it’s frustrating to see how little impact he has had so far. Suffice it to say that Jamie is less sanguine than I am, but he understood my view that owning stocks through this period isn’t as perilous as so many think because Powell does get his man in the end. I think inflation is about to bend to Powell’s will. We just haven’t seen it yet. Jamie and I aren’t really that far apart. Inflation still sticky in housing, wages, food Now normally, the Fed would be fighting commodity inflation with policy rates — and, to be sure, that’s been the big battle that Jay has won. Almost every commodity has come down — and some, like copper , natural gas , are going down or have been down for the count. Nat gas, after a high near $10 per million British thermal units in August, has been falling so precipitously that it dipped briefly under $2 this past week. That’s what makes it so difficult to nail the worldview though. Commodities turned out to be an uneven match. Jay crushed them, helped unwittingly by China and Covid, of course. But the trio of rising home prices, wages and food, aren’t just sticky, they are seemingly impossible to stop. Who knows that will bring them down? The answer, of course, is if we get a dramatic increase in the number of people who will be out of work that will, sadly, do the trick. I posited to Jamie that I thought we could go to 5% unemployment if Jay took rates to 6%. He didn’t disagree with me. Fortunately, I don’t think the Fed has to go that far to break the trio. Unfortunately, my not thinking that Jay has to go that far and what he actually does could be very different. Maybe he presses much harder and faster. I think he’s prudent and he will not cause the plane to crash, although a harder landing for the economy than would have been necessary at one point is certainly in play. But let’s not lose the bigger six to nine month worldview: I think short-term policy rates, the ones that Powell controls, will top out within my timeframe. When that happens you can’t NOT be in stocks, especially names that will do well when the damage to the economy is most severe. Always remember, that stocks reflect the future, not the past. We have taken rates from zero to nearly 5% in no time flat. I believe we have at least two, maybe three more hikes to go before it’s obvious to all that wages aren’t going up; and if they aren’t going up, than housing is going to go down in price; and we will all be buying food with the names Kirkland or Great Values on it. Yes, wages are the linchpin of this economy. You break wages you break inflation. If there is one big takeaway here it’s that I think that Powell is going to bring wages to heel. We do have some signs that it’s beginning to happen. Retailers are telling me it’s easier to find workers. Restaurants are saying that they aren’t seeing job hopping any more. But it’s contradictory all over the place. Domino’s Pizza (DPZ) says it still can’t find enough drivers. But they can, of course, if the pay more but that hurts profitability. Every industry has some level where the companies can’t pay more, and they will fall behind because they can’t. Consider it Darwinian natural selection. For example, we keep waiting for some gigantic shoe to fall, for Andy Jassy, CEO of Club holding Amazon (AMZN), to turn around the woeful stock of the e-commerce and cloud giant by firing 200,000 people at once, the buildup of staff to address off-the-charts demand during Covid that has since become more normalized. However, if you are Jassy how do you know if some of those people you might fire will cause orders to customers to be a day late? It’s too difficult a decision to be so bold. You could end up pleasing the stockholders but damning the franchise, which stays ahead of all comers because the company can get virtually anything to everyone quickly — two days and sometimes even quicker. That said, I do believe, three Fed bumps from now we will stop seeing sporadic layoffs and slower hiring, and start seeing big firings – not just to make the quarter but to keep the institution alive. We will see otherwise solvent firms go belly up. There will be no new money to be had for the struggling. If you can tell me which month that will happen with any certainty, it would be very easy to invest. You’d have the ultimate piece of inside information. I demure and instead say that when we get near there, not there, but near there, it will be very obvious, at least in hindsight, too obvious to wait for. Here’s what I do know. I think that within nine months we will see the end of the Fed tightening. No, I don’t envision an immediate loosening, as those who own the 10-year Treasury believe. I just think that we have to have it sink into peoples’ heads that they are lucky to have a job and they will do anything to keep it, while they start conserving capital because the institution they work for may not even make it if the tightening continues. We have literally thousands of companies that have come public in the last three years or thought they were going to come public or had just been formed that I believe will not survive if the Fed takes policy rates beyond 6% and keeps them there. The bad news is that there would be lots of destruction at 6%. The good news is that wages, the root of all inflation, will be slain. The increases that we have seen will effectively be finished. That’s the view that we are picking stocks under right now. It’s a view that directs our thinking. We put our stocks through that meat grinder of a view before we pick anything. We augment that view, with a determination to have a diversified portfolio. I am not so arrogant as to view that I know I will be right. Our cash position at 8%, would be at 18% or higher if I thought Powell were ineffectual. He isn’t. He’s determined. He will take rates up by whatever increment and whatever timetable until it’s clear that we are all afraid we are going to lose out jobs. I am saying that level is less than a year away. Given that distance, we can’t afford to have a monster cash position. We can’t afford to have all cyclicals because the Fed will hurt their prospects. We can’t afford to have all health care and packaged goods stocks either, the stocks that do well in a recession, because we aren’t looking for a recession. We are looking for wages to stop going higher. There’s mounting fear that small medium and even large companies won’t get financing. A recession? It’s an abstraction, some term that makes this process sound oh so clinical when it is anything but. We think company by company – not recession by recession. By the time one would be declared we would most certainly be in the wrong stocks if we don’t act now, that’s how close we might be to an end to this cycle of pain. Bottom line To sum up what is the backdrop behind so much of our thinking: the Fed is going to win its battle against inflation as defined by flat or even declining wages across the board. We think it will happen within a year. Will it be 6% rates that does it? I think so. Maybe less. Can you own stocks into this? After what we have been through in the stock market, I say of course. Can you own stocks of companies that are losing money right now with that worldview? Absolutely not. That’s why I am so doctrinaire during “Mad Money’s” Lightning Round segment. The companies you think might not make it I think aren’t going to make it because they won’t be able to raise cash. The fear, which seems unimaginable now, will be palpable a year from now. The jobs that seem so secure will be anything but, and the marginal employers won’t be able to hunker down. They will disappear. Notice, though, all of this hard talk cannot be met with “better go into cash.” It can’t make you into a turtle with its head in its shell. It should make you be incredibly worried about companies that sell at ridiculous multiples to sales or earnings, the very stocks that did so well before. It should make you concerned that if there is no big dividend or special reason to own a company, those shares could go lower with this worldview. Maybe appreciably lower. Always remember that there is some “gut” to all of this. Some emotion that can’t be expunged. Some muscle memory of a collapse that shouldn’t even be recalled. But, if I believe that we can see the end of the tightening cycle even as it will be rough for many on the way there, then I better be constructive toward the asset class that is stocks. Now, it’s just a question of picking the right ones for that worldview, acknowledging always that there are unseen risks that I am not ignoring but accepting will happen and we will be ready for them. I know, it’s a long way from having a Toll Brothers report thrown into my face – but, as Steinhardt used to say when I ended up making him money, it’s a lot better than a sharp stick in the eye. (See here for a full list of the stocks in Jim Cramer’s Charitable Trust.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust’s portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED.
I presented the following at the first-ever Investing Club “Annual Meeting,” held in person in New York City on Saturday and simultaneously live-streamed. Here’s the full video replay.
DUK Editor TeamFebruary 27, 2023