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Kass: Harder Than the Average Bear

Doug Kass

The natural rhythm of the markets has been disrupted since, sometime in September 2008, investors came to the realization that the current economic downturn was not going to be of a garden variety.

It was at that point in time that the decline in equities gained speed in the face of the failure of Lehman Brothers, along with growing recognition of an abrupt deterioration in business activity around the world. As a result of Lehman's demise and the accelerating economic downturn, credit eroded, junk bond spreads widened further, and the price of bank loans plummeted.

The magnitude of policy relief that has been heaped on our current condition in order to re-inflate the domestic economy underscores how different it was this time as we attempted to deflate out of the previous credit binge.

In the old days, recessions were anticipated by the stock market. But in late 2008, as George Soros related in The Alchemy of Finance, market participants seem to be shaping the slope of economic activity as the decline in equities is serving to deepen the downturn. Indeed, the swift drop in stock prices on top (and into a continuation) of lower nationwide home prices has recently fed a negative feedback loop as the acceleration has had a materially adverse impact on consumer and business confidence. As a result, the outlook for personal consumption expenditures and business fixed equipment has dimmed over the balance of 2008 and into next year.

Though share prices seemingly discount anything short of a Great Recession, visibility remains ever more clouded and a wide range of S&P 500 profit outcomes from 2009 to 2011 seems, to this observer, to be an important contributor to an unprecedented degree of volatility not seen in our professional careers. And that volatility is being exaggerated by a trigger-happy and rapidly consolidating hedge fund community that seems to accentuate both upside and downside market movements.

A description of what has happened in the past and what is now happening is easy; how to respond tactically and how to adopt a reasonably accurate vision of the future are much more difficult.

Positives and Negatives

The largest positive is that most now believe that the Fed and Treasury are pushing on a string as investment, economic and profit expectations have begun to adjust to reality:

• The Cassandras -- Nouriel Roubini has guest hosted CNBC's "Squawk Box" on three occasions in the past six weeks and is now touring the globe to standing-room-only crowds as an economic consultant! -- are now out in force.
• The discredited Polyannas -- even "Steady Eddy" Ken Fischer and many other permabull managers are suffering and are getting redeemed! -- are in hiding, however, nowhere to be seen, and, they, too, have turned their back to Goldilocks, as the NBER yesterday put an exclamation point on the U.S. recession.

The largest negative is that stocks are still reacting poorly to weakening results, and those negative but lagging fundamentals will likely to be with us for some time to come.

We all recognize that, in the fullness of time, an unprecedented amount of stimulus will, well, stimulate! The only question is when.

My view is that it is simply too hard to have conviction until we meet the following conditions:

• stability returns to the hedge fund community, as redemptions slow down, some large hedge funds fail, and money is re-circulated to other investment managers;
• the slope of the domestic economy's downturn is better understood, as the possible recovery is seen with better clarity; and
• the volatility in the capital markets diminishes.

Until the above three conditions get resolved, we are likely to be stuck in a broad trading range of plus/minus 10% to 15% for the short term.

We remain in an exquisite backdrop for traders but a difficult and frustrating setting for investors, in which it may be too late to sell and too early to invest for the long term.

At some time in the future (possibly sooner than later), a historic buy-and-hold opportunity will be in front of us.

The current test for investors is to remain solvent until that time is near.

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Know What You Own: Doug Kass alludes to the turmoil in the financial sector, and some of the survivors in this field include JPMorgan Chase (JPM Quote), Wells Fargo (WFC Quote), Bank of America (BAC Quote), Citigroup (C Quote), Royal Bank of Canada (RY Quote), Bank of New York Mellon (BK Quote) and Toronto-Dominion Bank (TD Quote). For more on the value of knowing what you own, visit TheStreet.com's Investing A-to-Z section.

Doug Kass writes daily for RealMoney Silver, a premium bundle service from TheStreet.com. For a free trial to RealMoney Silver and exclusive access to Mr. Kass' daily trading diary, please click here.