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Kass: Welcome to Dystopia

Social Change

  • We face a changing social fabric and a behavioral revolution. The financial meltdown and wealth destruction is not just a financial event; it will contribute to cultural and social change. New trends will emerge; most will downsize. For example, young adults will likely be living with their parents for longer periods of time, and consumers will be trading down from well-known (and more expensive) branded products to cheaper generics. Generally speaking, future expectations of all sorts will be reduced, and learning to live within one's means will become increasingly commonplace.
  • Our educational system faces upheaval. Expensive private institutions will face a sharp falloff in admissions, while state institutions will flourish and admissions will grow more competitive. Losses in university endowments will result in larger classrooms and layoffs in personnel.
  • Municipalities will offer less services, and our military will be downsized. Sanitation, post office, fire, police departments and our armed forces will contract in size, and less will be expected of them.
  • Regulatory reforms will multiply. As a consequence of the most recent period of self-dealing and of unregulated, unbridled and often senseless growth (particularly through the use of credit), the laissez faire attitudes of the past are now over. The pendulum of regulation, similar to the pendulum of credit, will become exaggerated. Our society and our corporations will become burdened with a quantum increase in the cost of regulation that will not only impede profits but could also stifle creativity.

Political Change

  • Populism will be on the rise. It is said that when the individual feels, the community reels. An understandable distrust toward the authority of our government and our economic institutions (especially of a financial industry kind) will create a fundamental backlash that favors the consumer over the corporation. This will have a significant impact on corporate tax rates (higher) and middle-class tax rates (lower).
  • Isolationism will also be on the rise. Nicholas Kristof's Sunday New York Times op-ed column discusses how the Bush Administration has "wrenched the U.S. out of the international community." I am afraid (for now) that the economic woes are simply too grand and Kristof is too optimistic about the U.S. rejoining the world community. The U.S. must turn inward over the next few years as dealing with our domestic financial problems will trump other priorities.
  • A more youthful Democratic Party will gain and remain in power. The Congress will lean decidedly more Democratic as there is growing recognition that our economic burden to finance our current tax cuts, war and bailouts will be immense and that the obligation and solution lies squarely on the shoulders of our children and our children's children. Younger voters will turn out in record droves in the years to come as that constituency will seek greater representation, serving to turn our political leadership markedly more youthful and more liberal in its conscience.

Economic Change

  • Credit will be dear for years. The pendulum of credit, which moved to the extreme (read: plentiful) prior to the recent travails has, not surprisingly, moved toward the opposite end of the scale (read: unavailable). When one combines the still capital short position of the banking industry with a deteriorating loan-loss cycle that stems from the economic downturn, the suggestion is that credit will be dispensed gingerly for some time to come. Lending institutions will err on the side of prudence and conservatism in their pursuit of re-accumulating internally generated capital, leaving a recovery in credit availability several years away as well.
  • Retail sales will remain sickly for an extended period. With stock and home prices dramatically lower, personal consumption will be diminished vis-a-vis past recovery cycles as personal savings rise back to historic levels.
  • After stabilizing in 2010, annual home price increases will be modest and locked in a decade-long range. Deflationary forces will stay in place for a longer period than the consensus currently anticipates.
  • Visibility of future corporate profit growth will be lost. Economic bulls, many of whom missed the unexpected drop in corporate profits that is now so apparent, still feel confident that S&P 500 earnings will trough at about $70 next year. Unfortunately, there is no clarity to that number; more important, there is even less clarity beyond 2009. In the absence of hard and predictable corporate profit figures, it is very hard to have a sense of whether the market has discounted next year's profits, so volatility will likely continue to be high. The softness and lack of clarity to earnings and continued high stock market volatility remain P/E-diminishing developments.

Investment Change

  • Investor disinterest and apathy lie ahead. As I have feared, the consequences of the credit morass (among other things) will likely be a growing distrust of Wall Street and of politicians, as well as a nearly unprecedented apathy and disinterest in investing, which could extend for years. For some time to come, inflows into mutual and hedge funds will no longer provide support to equities; in the absence of evidence of a strong marginal stock buyer, a period of substandard investment returns (at best) seems the most likely outcome.
  • Wall Street and private equity will never be the same. Stock commissions will drop, capital market activity and volume will moderate in a secular sense, Wall Street employment will be cut to the bone (and will not rise for years), and industry compensation will be a shadow compared to the "good old days." Business school classes will drop materially in size as law schools and medical schools undergo a renaissance.
  • The dominant investor of the New Millennium will become less dominant. The hedge fund industry shake-out has only just begun. Fee discounting will become prevalent. The fund of funds industry will be nearly extinguished over the next few years as additional layers of fees are almost impossible to rationalize during an extended period of historically weak investment returns.
  • Investment conservatism will replace the hedge fund go-to strategies. Fixed-income strategies and new, more conservative investment vehicles will likely gain popularity.

In summary, my vision of the next three to five years is one of less economic clarity, more economic conservatism, rising populism, a more youthful government and muted investment expectations and returns.

It is a vision not of utopia but of dystopia.

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.

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.
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