Doug Kass: What If David Tepper Is Wrong?

The battle of investment wit continues.

David Tepper’s CNBC interview Thursday and FinTV’s coverage of it caused more than a ripple in the markets (here it is). At one point Thursday the S&P 500 dropped by nearly 3% or 115 handles.

Let me start by writing that my admiration for Tepper runs deep, as, over the years I have written in very complimentary terms about him. In fact, I consider Tepper (along with Stan Druckenmiller and Baupost’s Seth Klarman) as the three greatest hedge fund managers in modern investment history. Even above Warren Buffett.

This column will serve to explain why, in this instance, I respectfully believe David may be wrong in his ursine view. I would note that, as always, I am always in doubt and often wrong. So, while I used the market weakness Thursday to expand my long exposure, I, like Tepper, might be incorrect in my conclusions.

” You keep using that word. I do not think it means what you think it means.”

– Inigo Montoya

A Deeper Dive into David Tepper’s CNBC Interview – “It Is What It Is”

In his interview Tepper made a number of points and observations, which resulted in his “leaning short” of the markets:

— Financial conditions have eased, which means that the Federal Reserve, and other central banks, may be more hawkish than the consensus indicates. Tepper cited a recent 90 basis point drop in mortgage rates, narrowing junk bond spreads (150 bps lower than in late September), a -60 basis point drop in the US Treasury note yield, among other factors.

— Indeed, the Fed, and other central banks, are telling us what they will do: They will remain tighter for longer.

— Inflation will drop from 8% to 4% — but it will be hard to get to 2%.

— Most investors are between 55% and 90% invested — he is “leaning short.” He mentioned he is also short bonds — which, as noted, a strategy that has likely gone against him in recent weeks.

— The upside/downside is unattractive given historical P/E multiples as a likely lower S&P EPS outlook for 2023.

— He specifically said he is “leaning short” right now. Meaning, to me, he may change his mind at any time.

— We might be moving into a mild recession.

— As to what the P/E multiple should be, based on history P/E expansion should be limited. We were 11x-12x coming out of The Great Recession in 2010 compared to 17x now.

— Even with the recent market drop, stocks have compounded at around a +7% annual rate over the last decade. That’s a healthy rate of return.

In actuality, what David Tepper did was to deliver the consensus view on the Fed and its likely actions, inflation, valuation and stock prices. Many of us, like Morgan Stanley’s Mike Wilson, and others including myself, have been concerned about the market and many of the factors that Tepper discussed on CNBC for the last 12 months.

But, more importantly, the consensus has already shifted towards David Tepper’s view over the last few months.

In other words, he delivered consensus and nothing incrementally new.

In addition, I would offer that David Tepper may have fallen into one of the classic blunders, though he clearly is far smarter than Vizzini in The Princess Bride who famously uttered:

“You fell victim to one of the classic blunders — the most famous of which is, “Never get involved in a land war in Asia” — but only slightly less well-known is this: “Never go against a Sicilian when death is on the line”! Ha ha ha ha ha ha ha! Ha ha ha ha ha ha ha!

Rather, David Tepper, for one of the few times, may be making a mistake by applying first-level and consensus thinking.

Give me, instead “second-level thinking,” as nearly all of the concerns expressed by Tepper are well known and may already have been discounted.

One more important observation.

As to his concern about the continued hawkish role of central bankers, in a tweet Thursday I argued that, while I understand Tepper’s message that we should not fight the Fed, the markets have already fallen dramatically and good inflation shows sign of moderation. Wage inflation remains problematic, but that too is a “known unknown.”

Moreover, arguably, many large-cap equities with intact franchises, and deepening moats have been obliterated.

But perhaps, even more importantly, is that much of the Fed tightening is behind us as the Fed has already raised Fed Funds to over 4% and is likely within 75 basis points of reaching its terminal rate:

While I can understand David Tepper’s view not to fight the Fed – what I don’t understand is why now – after the market has fallen and after the Fed has raised the Fed Funds rate to over 4% and is likely within 75 bps or so from the terminal rate. @jimcramer @tomkeene @ferrotv

– Dougie Kass (@DougKass) December 22, 2022

Bottom Line

“Inconceivable!”

— Vizzini

While I admire David Tepper tremendously (I am even a fanboy!) and I believe there are a number of factors that could restrain the upside advance of equities, the reasons offered in David Tepper’s CNBC interview on Thursday were not actionable reasons to this observer.

Most of the negative factors mentioned are known and nearly all of them have been accepted by the consensus.

Indeed, a 2023 recession — feared by David Tepper — may be the most advertised recession in history!

The core critique I have to his interview, and the market’s negative response, is that he expressed too much “first-level thinking”/consensus and too little “second-level thinking”/contrarian.

From my perch, the business media reported Tepper’s comments in a hyperbolic manner and may have contributed to an overly emotional response taking down the S&P 500 by 115 handles, or nearly 3%, at the morning lows. Their accounts of Tepper’s interview overstated the intensity of his bearish views — as, in reality, he was more measured than generally reported.

As stated on numerous occasions, this is a challenging market. But it is a market that should be approached unemotionally.

For me, and as always I might be wrong, with the S&P cash index moving toward the lower end — cash traded as low at 3770 at Thursday’s low — of my expected trading range (3700-4100), my view is that Thursday was an opportunity to buy and not to sell.

Despite David Tepper’s warnings and the market’s adverse reaction, I got longer of exposure.

(This commentary originally appeared on Real Money Pro on Dec. 23. Click here to learn about this dynamic market information service for active traders and to receive Doug Kass’s Daily Diary and columns each day from Paul Price, Bret Jensen and others.)