Exclusive Interview With Doug Kass

Last week, I had the opportunity to interview noted market participant and commentator, Doug Kass. Mr. Kass runs a hedge fund, Seabreeze Partners, and is a frequent guest on CNBC. Below is the full transcript of our interview.

Q: What is your opinion on 2009 Wall Street bonus levels and the perception of asymmetrical compensation practices at large banks that received bailout funds?

A: In the old days when brokerage firms were private companies, there would never been any talk of excessive compensation as the firms generally speculated with their own partners’ capital. Back then, they “ate their own cooking” and were dutifully attentive to the relationship of risk and reward in their own proprietary trading. They had some bad years when the capital markets were difficult to navigate but, in the main, losses were contained. (Bear Stearns’ Ace Greenberg epitomized the respect for capital when he used to be mindful of the bottom line (and too many paper clips!) as he often quoted the revered Haimchinkel Malintz Anaynikal, a reclusive philosopher of budgetary restraint who resided in the fertile imagination of Ace's mind. Goldman Sach’s John Whitehead and many other brokerage chiefs also epitomized that frugal and risk averse era as well).

But, the industry’s respect for capital changed once the brokerage companies all went public (and began to trade with “other people’s money”) and when our politicians introduced more liberal legislation that increased the ability for financial institutions to leverage their capital. A “heads I win, tails I win” attitude towards risk taking permeated our financial companies as the compensation carrot grew so big.

Going forward, I believe reasonable restrictions on compensation should be placed on both companies that have and do not have government financing. Both should be subject to broad restrictions for the “public good” in order to avoid possible systemic risk. One of my intermediate term solutions is, that when brokerage industry conditions and operating results stabilize, we would be far better off if brokerage firms converted back to private form. I can guarantee you they wouldn’t take outsized risks with their own partners’ capital.

Q: What was your best, or most memorable trade?

A: My most memorable trade was when I was a graduate student at Wharton in the early 1970s. I was an active investor even while I was getting my MBA. After spending a week analyzing the company, I bought a few shares in Teledyne (run by a true corporate genius, Dr. Henry Singleton)... One month later, in 1972, the company made a large tender (it was the first of eight tenders between 1972-1984) well above it's closing price. I purchased a TR4A automobile with my profits in the TDY trade!

Q: What is one investment theme which you are very confident in for 2010?

A: I am most confident in the notion that the consumer will be an albatross around the neck of our domestic economy and will be the principal force in producing a shallow recovery in 2010-11. The unemployment picture will remain weaker for a longer period of time than is expected as corporations do without more workers - so the general welfare of the all-important consumer will not improve much. Small business confidence and expansion plans will stay low because of tax, regulatory uncertainty and limited access to bank credit, so hirings will also disappoint from this important source.

For these reasons and others, decades of an aspirational and rabid spending U.S. consumer, who has had an almost unlimited amount of available financing -for the purchase of homes (often more than one!), goods and services - might now be coming to an end. The consumer might even retreat to the legacy that followed Americans after the Great Depression – maintaining the status quo will be their new objective. The comfortable and secure consumer will be one that has a lot in the bank not an extra handbag or automobile. Retail stocks should be shorted – perhaps even with impunity!

Q: Is inflation going to become an issue down the road? What are the consequences of the Fed's monetary policy?

A: Given the large output gap (low factory operating rates relative to capacity), the surplus of world savings, wage deflation (caused, in part,by globalization), the likelihood of a continued depressed housing market (home prices will be pressured by the trickling out of a large phantom home inventory into the marketplace), and my below consensus economic view, I don’t see inflationary pressures over the next 12 to 18 months. The due bills of our trade and current account deficits will come – but it is probably a 2012-13 issue. Interest rates will remain low and will stay within a narrow range.

Q: What are the chances in your estimation of another major financial crisis in the next ten years? Will the extreme boom and bust cycle we have seen in the 2000s become the new normal?

A: The chances of another financial crisis is very low. The pendulum is moving towards lower consumption, more restrictive credit and, in general, fiscal conservatism – these are anti-speculative influences. Moreover, the burden of regulation will be hard felt by our financial institutions that are going to be forced to de-leverage further. Inexpensive and abundant capital, which has historically been the root of speculation and, ultimately, of crisis, will be less plentiful than in prior cycles.

Q: Will the extreme boom and bust cycle we have seen in the 2000s become the new normal?

A: No, the new normal will be boring and will likely be lacking of a speculative flair. Economic growth will be shallow and will be well below historic averages. GDP growth will not be smooth like the consensus is forecasting. More likely an inconsistent pattern will emerge with one quarter looking like we are moving out of the recession and the next quarter feeling like we are moving back into a recession. Both corporate managers and investment managers will find the environment difficult to navigate in.

Q: What is one paradigm that aspiring traders or investors must adhere to or understand in order to find success?

A: There are five basic tenets to investing success that I would give to any trader or investor: (1) Stop your losses and let your profits run. (2) Don’t use leverage. (3) Be diversified. (4) Always remember that it is better to lose opportunity than lose capital. (5) Don’t forget #1!

Q: What was the worst job that you ever had? Did you learn anything from that experience?

A: While in college I worked for Manpower for the Summer. I spent eight weeks cleaning out dirty ovens in a restaurant. I learned that I would rather analyze companies in a suit on Wall Street than clean out dirty ovens in an old restaurant.

Q: With regard to the 20 predictions you have made for 2010, which is the most compelling in terms of shaping economic events this year. For example, if treasury yields do indeed fall, what are the implications of that? Does that mean fear has reentered the market place in a major way and there is a flight to safety?

A: I have argued that among the most important challenges to the economy and the capital markets is populism. The angry subtext and poor attitude toward big business and the wealthy has rarely been so bad. Populism threats are woven into many of my surprises for 2010. The biggest surprise will be that the tidal wave of populism will intensify and will be with us for years. So will be higher taxes and costly regulation. This will stunt economic growth and will deflate stock valuations.

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