Kass: The Headwinds Keep Getting Stronger

Capital Markets Focus on Liquidity

The world's equity markets have exhibited extraordinary and consistent strength. The capital markets have ignored all of my concerns and have focused on the tide of liquidity (leading to a plethora of private equity deals) and the view that first-quarter earnings appear strong (and corporate profit margins remain invulnerable), while government readings give the impression of relatively low inflation and the growing view that the housing problem will be contained.

By contrast, I believe that equity and fixed income markets/risks are being materially mispriced, the capital markets (and hedge funds and their investors) are increasingly levered and tightly wound (Warren Buffett described the proliferation of derivatives "as financial weapons of massive destruction" over the weekend), inflation is far higher and U.S. economic growth is far weaker than is generally assumed, corporate profit margins have likely peaked ("Corporate America is living in the best of all worlds, but ... I would not expect corporate profits to continue to be 8.5% of GDP far into the future" -- Buffett again), political and geopolitical risks are elevated, and the housing market is moving into another leg down.

I recognize that to many -- in light of the market's steady advance -- I might sound like a broken record in espousing the belief that a U.S. recession remains possible (certainly "blahflation" is likely!) and that short-selling opportunities remain bright.

Mark Twain once supposedly said, "History doesn't repeat itself, but it rhymes." I suspect that our capital markets will have something that rhymes with both 1998 (when the markets suffered from the adverse consequences of leverage in Long Term Capital Management's failure) and 2000-02 (when the piercing of the speculative equity bubble led to a material drop in the major averages).