Aiming for the Market’s Bullseye

IBKR’s Steve Sosnick discusses fundamental investing strategies, risk management and American ingenuity with Traders’ Insight contributor Adam Johnson, Chairman and Publisher of Bullseye Brief.

Summary – Traders’ Insight Radio Ep. 11: Aiming for the Market’s Bullseye

The following is a summary of a live audio recording and may contain errors in spelling or grammar.  Although IBKR has edited for clarity no material changes have been made.

Steve Sosnick (SS)

Hi everybody, welcome to Interactive Brokers, Traders’ insight radio.  Today’s is February 16^th.  We’re taping this podcast with one of my friends in the business, Adam Johnson, the chairman and publisher of Bullseye Brief.  He’s been a contributor to Traders Insight for several years now as well.

I think that’s how we met, making the mutual connection once I started to move out from the trading desk full time and start publishing.

Why don’t you introduce yourself to everybody and we’ll get going from there, Adam.

Adam Johnson (AJ)

Oh, thanks for having me, Steve.  It’s great to be with you and love the Interactive Brokers team.  I mean you guys are just the best.

You know, I’ll come up with a cool chart, write a paragraph or two and inevitably I get a call from the team: “Hey, do you guys have anything this week” and we’ll put it out there and I get a bunch of comments and feedback so I love being part of the community, and I write an investment letter called Bullseye Brief, in which I focus on American ingenuity — the people and companies driving the world forward.

So obviously I’m a growth investor.  I’ve got a lot of tech, a lot of biotech, a lot of med-tech.

I put out a new stock pick every week.  I tell people what I’m doing in the portfolio, and we grow together. You know, we’ve outperformed the S&P 500 pretty significantly since I launched this thing in 2016.  It’s a lot of work, but it’s a labor of love, and you know if you do what you love, you’re not really working.

SS

And no one said this is easy.  All in all, it requires work.

AJ

This is a lot of work, and in this market let me tell you it’s a lot of patience too, because for a couple of years it was like every time I bought a stock it just went up.  In fact, it was getting to the point where guys were kind of creeping in.

SS

Oh, that’s such a big problem.

AJ

Yeah, but seriously, guys were pinging me on Thursday and Friday because I published on Sunday morning.  And you could just tell they were trying to get me to sort of say what I was going to publish on Sunday, ’cause they wanted to get a jump on it and you can’t do that.  Everybody has to have a fair shot Monday morning.   You know, in a bull market, if a guy like me comes out excited about a name and I’ve got followers all over the world, so you know there’s buying interest in the thing pops up.

At this point in time, you just want money to come around and for it not to open down like everything else.

SS

Yeah, this we’re going to get into the current environment and how it’s changed in a little bit, but I think the listeners would be very interested to hear your background, which is quite interesting.

AJ

Yeah, well, thank you.  I thought I was going to be a doctor and I went to Princeton as a premed and my ECON 101 Prof was Alan Blinder, former vice chair of the Fed. 

I went up to him one day after class to ask a question and he said, “remind me your name again”. I said, “it’s Adam Johnson.”  He said, “Yeah, and what’s your major Adam?  I said, “well, it’s probably molecular biology because I’m premed.”  He goes, “That’s a bad idea.”  I said, “Professor Blinder, why?”  He goes, “Because you’re the only one who comes up to me every day after class and asks questions.  I think you like economics and you should be an economics major.”

And admittedly in that moment I it changed my whole life so I you know, ended up majoring economics went to Merrill Lynch to their analyst program.  I structured mortgage backed securities because I wrote a thesis on mortgage-backed’s.  How I got there from molecular biology I don’t know, but whatever.

And then I traded oil for Louis Dreyfus for a number of years.  Eventually I left oil, and went to a wonderful firm called Furman Selz, where I traded stocks and stock options for a number of years.

We sold ourselves to ING the Big Dutch bank and started a hedge fund with a few guys including the CEO and started going on television eventually as a guest.  That was during the financial crisis and Bloomberg said, would you ever join us full time as a TV person?  So, my then-mentor said, “you know, no one gets a shot like that. Why don’t you do it?”

I was at Bloomberg, I loved it. I was there for five years on air every day for three hours, but I missed being in the game and so I left.

I launched Bullseye.  I’ve been doing that six years and you know, Bullseye is my life story, right?  It’s analyzing companies or my professional life story. Analyzing companies for many years, then going to Bloomberg and talking about companies. Now, I’ve brought it together as bullseyebrief.com, so that’s the story.

SS

I wanted people to get that perspective because you’ve got a very varied background.  You know lot and you’ve done several different parts of the business.  I think that provides you with a lot of perspective that people don’t have.

AJ

Well thank you.  I mean, at times it’s felt like left turns, but you know in retrospect, as I look back and even as I hear myself tell you the story, it actually makes sense. Each thing logically needed to lead to the next, but in the in the fog of war, sometimes it’s hard to see the way forward.

SS

Let’s talk about navigating this environment because the last couple of years I think have given people sort of a, I’m going to call it a false sense of security.  And that is to some extent that’s been changed over the last month or so.  Tell me how you’ve really navigated what I’m going to call a challenging environment for fundamental investors because fundamentals tended to matter a bit less when the tide was rising.  How did you navigate this?

AJ

Well, it’s not been easy.  Every day there’s a blow up and a lot of the blowups aren’t justified.  I mean, you look at some of these. These companies that come out and marginally miss earnings or lower the lower end of the forward range of guidance. And suddenly the stocks down 20%, you say, “really, 20%?” but the algos have jumped on everything.

There are two things and history has proven that these two strategies are generally successful, but right now we’re still in the thick of it. The first thing I do is I make my position sizes smaller, so instead of having 4% of capital at cost in every name so in other words 25 positions. Each is different, yeah?

SS

Instead of 25 stocks you have more or less concentrated positions among a bigger list of names?

AJ

Yeah, well what I’ve done is I’ve lowered the 4% to 3%, right? So, in theory you know it’s three. It’s 25 3% positions.

SS

Oh, so you’re carrying more cash?

AJ

We’re carrying more cash and by doing that and saving a little ammo when I get a blow up, I can come in and buy something down 20, 25%.  And I don’t feel like I’m already choking, so I think having a little more cash in order to be tactical when you need to be is one thing to do.

And the second thing I’ve done is I’ve really stopped staring at the screen every day.  The worst thing a guy like me, a long term investor, can do is stare at the screen.  I’m not a trader.  I mean, I’ve been a trader in my previous lives but I’m an investor –that’s what I do.

I’m trying to again find the people in companies I explore.  The people in companies driving the world forward and that takes time.

My average holding period is well over a year, so you know it’s kind of silly for me to just stare at the screen from Tuesday at 2:20 PM to 2:40 PM and get all worked up.  So, smaller positions and looking at the screen, less, that’s two ways I’m dealing with the sort of madness of them.

SS

The way I unpack that, and correct me if I’m mischaracterizing it, is something I’ve been preaching, which is that cash is your friend when volatility increases.  That’s #1. #2 was an old market making adage that we used to have in big red letters on the wall of the room:

When it gets crazy,

 Shrink positions sizes.

Widen spreads.

Raise volatility.

Now you’re not trading options, so the third one doesn’t apply.

But to me this is a very good lesson from an experienced investor.  Whether you’re trading short-term or investing long-term, the mentality is quite similar, which is: when things get rocky you have to have a little less conviction and you can’t be pedal to the metal and everything.

So, from a market making point of view, if we were willing to be 25 up on something and it’s volatile, you’re 15 up.  Or, if you’re used to trading with a 10 cent spread, you’re trading with a 20 cent spread.

In your case, because you’re not trading, you’re investing, that’s adding cash as ballast to your portfolio that allows you to be opportunistic.

 AJ

Yes, oh absolutely, and you know, it’s hard to do that.  You know, it’s really hard in the moment to say, “OK, I’m going to take my position sizes down.”  I mean what’s suddenly changed?  Why are you suddenly bearish?  You know, it’s just hard to do.

Look, we can go back and realize that on November 8th of last year the five-year breakeven forward on the TIPs spread blew out to like 338 — the widest it had ever been — and in that moment everyone said, “Oh my gosh, maybe this inflation is no longer transitory.”

Which, by the way, well ahead of Jerome Powell’s admission.  He came out, I think, like six weeks later and said the same thing.  So, the market figured it out and that was the day when all my beloved growth stocks stopped going up.  We can look back retroactively, and we’ll remember that lesson next time, because successful investing is about learning, being a student of the market, learning and remembering, and applying and reapplying so we’ll remember that lesson.

But you know, it’s really hard on a given day, whether it’s November 8th or April 23rd, or who knows when, to say “ahh, look at this, something changed. Therefore, I’m going to change it.” That’s really hard to do, and I think one way to try to capture some of that is to do what you and I are doing now, which is figure out a group of friends that you trust — kind of a pack, like a Wolf Pack — and you just share ideas, and you share stuff.  “Hey, I noticed this.  What do you what do you think?”

And you try to form a little mini consensus among yourselves.  That might be one way.

SS

I think it’s very important.  You and I have been out to dinner, and you know I’ve got this little pack that I do this with.  Not everybody is in the investment business either.  But I think it’s very important. It’s a good check on what goes on in the real world, and that’s a very important thing to do. Does this make sense?

Have things changed materially, or are we hearing noise?  And separating the signal from the noise can be very difficult to do, so it helps if you have other people who have good filters. Signal to noise filters to bounce stuff like that off.  As a growth investor, one of the things I’ve been pondering, and I’d like your opinion on this, is one of my assertions after last earnings period when they basically took Netflix and Facebook to the woodshed, is whether this is the markets way of saying what happens when a growth stock no longer grows?  Or do you see those as more temporary?

My assertion was this was the market — a market that in many cases had become in love with growth at any price as opposed to growth at a reasonable price — realizing that if there is growth premium, and if a company is not growing, that growth premium comes out in a heartbeat.  As a growth investor.  I really want your take on something like that.

AJ

Well, yes, I agree with you that there is a repricing happening.  In other words, if you used to be able to say “sure, I can justify paying 20 times sales”, now you’re saying, “no, I can pay 10 times sales.”

Or, “well, actually, maybe price to sales is no longer valid.  Hey, what about price to cash flow?

Or, “oh my gosh, price to earnings.  Holy cow, you know, we need real profits”

So yes, there’s a repricing that’s happening at the growth end of the spectrum.  But you know, it’s not just growth.  I mean, Disney got whacked 25 or 30%, Blackstone got whacked 25 or 30%, Starbucks… On and on and on.

These are great companies and I think a lot of what’s happening is that the algorithms the computer based training programs are latching onto headlines, and because they no longer need a plus tick to short stock they’re just hit.

Beating stock and clearing bids and pushing stocks as hard and as fast as they can, sometimes based upon just one headline, which may ultimately actually prove incorrect. 

In one of my biotech’s, the first headline came out and it made it look like the company did not produce strong data.  And then if you actually read the second half of the sentence, you realize no, it really did.  So, the stock went down 25%, and then not only came back up to even, but went up 25%. It had a 50 percentage point range in maybe 7 minutes because some people actually not. computers read the press release again.  What a concept! 

Wow, we actually read the press release.  We listened to the CEO.  We ran the numbers.  Computers don’t do that, and I think right now the algorithms are the dominant investors in there.

They’re exacerbating volatility based upon trading lines.  It’s making life hard, and this too shall pass, but right now I feel like they’re in control.

SS

I’m going to agree to a point on that one.  I think from a trading point of view, you’re right and I’ve been on the other side of this.  The machine reading algorithms are hyper aggressive and they’re indiscriminate, and they use whatever means are at their disposal to establish the long or short exposure that they want.  And I do think a certain amount of fundamental investing is being handed over to the machines.  As well, you know if you change the denominator in your equation, it’s going to change the valuation of the company.

Where I push back a little bit is in the case of one of these stocks getting whacked on earnings.  If the computers were wrong, you’d expect to see the result that you saw with your biotech stock — where they were wrong and this was a great opportunity for someone who did read it and did understand it rather than a superficial headline.  What a wonderful opportunity to pick up a stock on the cheap.  Or if you’re a trader, to buy low, sell high.

In the case of some of the bigger names, I’ll argue that that some of the movement you saw in, let’s say a Meta or Netflix was machine driven, but you didn’t really see a huge bounce back afterwards, which would make me think that might be machine investing, but it’s not machine trading.

AJ

Yeah, uh, OK, that’s a fair point and I will sort of add to that that I think negativity right now has gotten the best of us.  And I could cite any number of metrics.  From University of Michigan Consumer Sentiment at a 10 year low, to about a week ago, the number of bears being at a multi-year high, or the number of bear bulls being in a multi-year low.  There are just so many sentiment metrics to suggest.

Look at the ratio of the P/E ratio of small caps to the P/E ratio of large caps.  It’s compressed to a 20 year low.  Small caps are as cheap relative to large caps as they’ve been in 20 years.  There is so much negativity and so I feel like the machines, especially on a negative headline, will start the momentum down, but then everyone just says ah, it sucks.  God, just sell it.  Everything sucks, you know, and we’re in this negative feedback loop and we will pull ourselves out of it.

I don’t know when, I don’t know why, but we will.  Because whenever sentiment gets that lined up on one side, as I believe it is right now by all these metrics, I’m mentioning it, it’s going to reverse, but right now it’s really hard to find a bull or to find an optimist or to find someone with a smile on his or her face.

SS

I have to second that opinion.  We’ve gone from somewhat euphoric to incredibly gloomy in a very short period of time, and I find it interesting because I have seen some really good inverse correlations between the price of oil and this gloominess, which is so superficial because it’s only one minor component of what we… I shouldn’t say minor, but it’s only one component of how we live our lives, right?

But it’s kind of fascinating, the rhetoric about how many people think the economy stinks when by any measure the economy is really good.  I think that there’s the psychological dysfunction.  I can’t disagree with you on that at all.  I think that’s perfect.

AJ

Yeah 6.9% GDP. I mean, that’s gangbusters. 4.2% unemployment that, according to my former economics professor Alan Blinder — the guy that changed my mind about Med school — He used to tell us that full employment was 6% and our 4.2.%

Earnings estimates, they keep revising them up because they’re too low.  Again, we’re too pessimistic.  I mean, it’s just amazing to me.

Thinking about consumer sentiment right now for a moment, Steve, isn’t it amazing? That sentiment is more negative now than it was in March of 2020. The depths of COVID when we thought the world was going to end or more negative.  Now, how can that possibly be?  I feel like we’ve lost the plot.  We’re all so freaked out about inflation and rate hikes that we’ve lost the plot, we need to snap out of it.

SS

I think that some of the nervousness surrounding rate hikes is weak and I want to talk about that more at length, because I think that the Fed’s actions and the Fed’s verbiage may or may not match what’s going on.  But I think in terms of the idea that people are so down on the economy, when I look at the numbers you rattled, we had retail sales numbers blowing away expectations.

I think it was Milton Friedman, I may have the economists wrong, who said don’t watch what they say, watch what they do and it’s very interesting.  Because people are.  Economic activity is going gangbusters, but yet sentiment is miserable and it’s it really is an interesting conundrum.

You know, if we have another two hours, we could get into the psychology of how we change the nation’s psyche, because of COVID and its response and the isolation, etc. That’s going to be the next thing that we’re reckoning with now, and history will show us what the answer is.

AJ

Yeah, for sure now. You mentioned rates and I’m not a psychiatrist, so I’m going to leave that one alone, but I will address rates for a moment because there have been four rate hike cycles since 1990. In other words, extended periods of time when the Fed was raising rates.  And if you go back and look at what stocks did in each case, stocks rallied specifically by an average over those four rate hike cycles by an average of 13% in 15 months. So, the notion that rate hikes or that rising rates is necessarily bad for stocks is actually wrong.  The data does not prove that out.

Ironically, when the Fed is lowering rates, that’s when it’s bad for stocks ’cause the Fed’s playing catch up and it knows that the economy is tanking.

SS

They’re lowering rates ’cause the economy stinks with raising rates because the economy is good.

AJ

Exactly. This is ironically when you want to buy stocks, so I think eventually people are going to kind of wake up and realize that they’re looking at it the wrong way, I don’t mean to be such a Pollyanna, Steve, but my hope is that when the Fed’s going to come out, start raising rates we’re gonna say, “OK, they’re finally doing it. Whoop Dee Doo.”  And people are gonna say, “wait, the economy is doing great, and unemployment is low, and earnings are on the rise.  OK, fine rates are going up.”

Real rates, meaning adjusted for inflation, are still going to be way below zero for a long time.  And when you do have inflation, what’s the single best asset?  It’s not gold, it’s stocks.  They go up the most.  We’re not there yet, but we’ll get.

SS

There it’s interesting because I do think a lot of the Fed’s jawboning is setting us up for that. I think what they like to do is see how much the market can bear. Sort of doing the stress test, as it were. You know 25 basis points, 50 basis points, 6 hikes, 5 hikes, 2 hikes.  See what freaks the market out and see what they take in stride, so that when the meeting happens in March, the market does take it in stride because it’s sort of been predisposed to it.

I’ve run the numbers.  I’ll see if we could link it in when we do this.  Before every Fed meeting for the last couple of years we have been running the totals.  Since they tend to be on Wednesdays, where are we on Tuesday afternoon?  Then where are we on Friday afternoon, figuring takes really two days to work its way through.  During the period from March 2020 on — and I may have the numbers not exactly right — but there were, I think, 12 Fed meetings.  I think for 10 of them we closed lower during that period and that was during a Raging Bull market when the Fed was doing nothing but pumping liquidity.

And in thinking about this, it was that people got so ahead of the Fed’s message that when they actually did speak and weren’t doing beyond what they were already doing, people got a little disappointed.

There have been four meetings since the Fed changed its tone a bit in September 2021.  After three out of four of those meetings, we’ve been higher in that period, and I think it’s the same sort of reverse psychology as people got so nervous about what the Fed might say or do vis-a-vis tapering, vis-a-vis rate hikes.

AJ

Oh wait.

SS

Whatever, the one exception was quarterly expiration in December.  Weird things can happen on quarterly expirations for various other reasons, but the other meetings since then we’ve been higher, despite the fact that we’ve been pulling back.  It’s a little bit of financial jujitsu or psychological jujitsu that the Fed does.  I think they kind of push the market in one direction and then the rubber band gets a little bit stretched.  I don’t think it mattered much during a Raging Bull market, if they pushed it too far and we pulled back a little, it ultimately did no damage.  But I think they’re trying to do the opposite here.  Sort of, see how far we can make it bend and then bounce back in the other direction.

The one problem I do have, and I’ve I ran some numbers today, February 16^th, and as of last week the Fed hadn’t really actually begun to taper.  And I think that may be a problem going forward because I think your points about the rate hikes and the markets performance in the face of rising rates, they’re borne out by data.  There’s no dispute to that.  Yes, that is the case.

I do think you know the most dangerous phrase an investor or trader could say is “it’s different this time.”  You’ve been around long enough to know that, but I do think that the amount of QE [quantitative easing] that we’re throwing in the system is something that’s different this time.

And I think it’s kind of interesting because I think the market has sort of taken the Fed at its word that we’re seeing a reduction in QE, a reduction in bond purchases, but the data doesn’t really show it. They’ve been going up over 100 billion a month still.  And I think that is what the biggest risk right now is, given the negativity when they actually do take their foot off the gas, so to speak.  They’ve talked a great game about preparing us for it, but in terms of the money flow, they really haven’t followed through with what they said they were going to do and so that to me is the big risk going forward.

In the spirit of bouncing things off of people I like…

AJ

Trusts whose views.

SS

What would be your take on that?

AJ

The Fed is walking a tightrope and I think that sentiment right now is very fragile around what they’re doing because I think half the people think that they’re hiking at the wrong time, and they think that because the inflation is coming from the supply side.

In other words, supply chains are screwed up, not from the demand side, meaning people are buying so much stuff they’re driving up prices.

And so, I think there’s a group of people who think the Fed is doing exactly the wrong thing at the wrong time, and there is a a probably more vocal and larger group that say “are you out of your mind?  They’ve let this thing go on way too long.  They should lock up Jerome Powell  — he’s been flooding the market with liquidity for years. Get rid of this guy.”

So there’s this weird, very polarized view, like everything like politics, right?  I mean everything is so polarized.

SS

Yeah, everything.

AJ

Yeah, that I think it’s making it really hard for the Fed to communicate and to do its job and to say here’s our path forward.

SS

That’s very well put because I think they really are in a box, and I will say Chairman Powell has been very deft at handling these circumstances.  And I think it behooves us all to root for him to continue to use his skill at managing these situations.

Now I know we’ve been going at it for a while, and I know we’re coming up on the time where we’d normally want to wrap up.  Is there anything we didn’t get to?  Is there anything you want our listeners to know about you, about your firm, about your market outlook?

AJ

Oh gosh, thank you.  Well, I’m the eternal optimist.  I love what I do.  I’ve taken it on the chin with some of my positions but that’s alright, I’ve still got plenty of winners.

The greatest story in the world right now is the American ingenuity story.  It’s the fact that we are producing more exciting technologies than anybody else, backed by well capitalized companies, more than anybody else, and whether you want to talk about artificial intelligence or clean energy or the digitization of physical assets, or the digitization of money, or automation, robotics, internet of things.

Steve, there’s so much momentum in this economy we will get through this crazy time, and I will continue to find wonderful companies for my subscribers to buy every week

SS

I can’t top that, that is that is you.  That is one heck of a coda.

I think we’re going to leave it there because, wow, that summed everything up for those of you who’ve been listening.  Thank you very much.

Once again, this is Interactive Brokers Traders’ Insight radio.  My guest today was Adam Johnson, CEO, publisher, jack of all trades at Bullseye Brief.  Please catch him here on Traders’ Insight or at Bullseye brief.com. It was a real pleasure having the opportunity to sit down and talk to you today.  Adam, thank you so much and we’ll talk again soon.

AJ

Oh Steve, thank you.

SS

Have a good one.