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Kass: We're in a Bear Market

This blog post originally appeared on RealMoney Silver on Aug. 17 at 7:48 a.m. EDT.

Sir Larry Kudlow has got it, and I genuinely admired his flexibility in his view of the new economic reality. Unfortunately, in part based on the seduction of yesterday's remarkable rip back from disaster, others have not.

Many on this site and elsewhere, including the cheering squad from CNBC who partied like it was 1999 only a month ago as the DJIA eclipsed the 14,000 level, contended that Thursday's ramp was a "psychological positive" and could be interpreted as the end of the recent swoon. They are guessing, and guessing has no role in an uncertain market.

The market's action in and of itself is only sometimes a "tell." The markets are never that easy to interpret, and the direction of short-term change in a market in chaos is simply a guess. (There is a good possibility that gamma and delta hedges coupled with short-covering might be the reason for a portion of Thursday's volatile session; then again, maybe not.) That's why I have been advising smaller-than-normal trading/investment positions.

Overnight Asian markets continued lower, suffering the largest weekly losses in 10 years. Japan bore the brunt of the decline, dropping by over 5%, the largest daily loss in seven years. Our futures, which were down by over 20 points when I arose at 2 a.m. EDT, indicate another lower opening into options expiration.

Getting back to "Kudlow & Company," I thought the first segment of the show, which incorporated a Fed discussion with Bill Ford, Lyle Gramley and Wayne Angell, was the single best learning experience I have ever had on CNBC as Sir Larry's experienced and informed panelists were straightforward in their visions of the current economic landscape and recommendations on how the Fed should proceed. ( Note: Though the attached tape of the segment is for subscribers only, it's worth the price of admission.)

On the show, I told Larry that one can attempt to solve the market's riddle (and future direction) by distilling it into one question: How much of the past prosperity of the last five to seven years in the real economy and in the financial vehicles that rule the universe (i.e., hedge funds) was based on the unusual creation of debt and leverage?

To make matters worse, we are now moving from an environment of high liquidity and low volatility to a period of low liquidity and high volatility. That means rapid and unpredictable market swings, not business as usual (or at least as usual as the last five years).

I went on to say that this decline has exposed the irrelevant rating agencies, opaque quants, misguided and momentum-based funds of funds as well as the avaricious packagers of stupid products on Wall Street. All will pay a price in this cycle. What I didn't have the chance to say is that all of the recent developments will likely serve the 2008 election to the Democrats on a silver platter, providing yet another headwind.

I suggested last night that those who believe a Fed interest rate cut will be a cure-all are mistaken. The problem in the current cycle is that nonbank financial entities (hedge funds, mortgage companies, Wall Street derivative players, etc.) have taken a greater role in the economy and have bypassed Regulation T requirements and banking reserve requirements. And those entities have been on steroids, raising leverage to levels never seen before.

Finally, I opined that we have entered a bear market and that any rally, particularly a violent one on the anticipated Fed cut, should be used to sell positions and to short.

Here are a couple more video clips from last night's "Kudlow & Company."

At time of publication, Kass and/or his funds held no positions in the stocks mentioned, although holdings can change at any time.

Doug Kass is founder and president of Seabreeze Partners Management, Inc., and the general partner and investment manager of Seabreeze Partners Short LP and Seabreeze Partners Short Offshore Fund, Ltd. Until 1996, he was senior portfolio manager at Omega Advisors, a $6 billion investment partnership. Before that he was executive senior vice president and director of institutional equities of First Albany Corporation and JW Charles/CSG. He also was a General Partner of Glickenhaus & Co., and held various positions with Putnam Management and Kidder, Peabody. Kass received his bachelor's from Alfred University, and received a master's of business administration in finance from the University of Pennsylvania's Wharton School in 1972. He co-authored "Citibank: The Ralph Nader Report" with Nader and the Center for the Study of Responsive Law and currently serves as a guest host on CNBC's "Squawk Box."

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