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Kass: Getting a Grip on the New Reality

This blog post originally appeared on RealMoney Silver on Nov. 11 at 7:44 a.m. EST.

Investors face unconventional headwinds today, both short and intermediate term.

As always, a sense of time frame is of paramount importance in matters of investing and trading. This might be more so today than in prior cycles as broad and systemic controversies have, by definition, uncertain outcomes and help to explain the almost unimaginable market volatility and the fatigue we all face when confronting routine intraday swings of 3% to 5%.

We have to be honest with ourselves and respect that the complexity of today's economic challenges renders the investment mosaic unusually ambiguous. It is hard to be convicted in any time frame.

I have emphasized that there are three important questions that we must ask ourselves in order to frame our stock market expectations. I'll present them again below but this time with my answers in italics:

    1. How deep and long-lasting will the recession be? While the largest year-over-year decline in GDP will probably be in the current quarter, it is unlikely that the economy will recover until late next year.

    2. Who will be the marginal buyer to sustain the current rally? With mutual fund and hedge fund investors withdrawing capital at a record rate and corporations likely to husband their resources (at the expense of accelerating their corporate stock buybacks), it is difficult to see a materially improving demand/supply equation for equities over the next six months that would serve to sustain a market advance.

    3. To what degree have current market prices discounted a weakening earnings and economic picture? Arguably, stock prices have, to some degree, discounted the weaker economic and profit backdrop.

The Short Term

There are a number of short-term influences:

  • Obviously, we have the selling associated with hedge fund redemptions.
  • Also, we must consider the degree to which fiscal and monetary policy will affect the slope of the economy.
  • Whither the emerging markets?
  • How broad will the Treasury's umbilical chord of capital need to be in order to stabilize the credit markets?
  • How long is the toxic reach of the arms of American International Group (AIG - Get Report) and Lehman Brothers?
  • Will there be a bailout of the automobile manufacturers?
  • What will be the effect of the change in our government's leadership?
  • Finally, remember that we have entered a period of seasonal year-end market strength.

Given that there are so many moving parts to the investment equation, about the only thing I am comfortable in writing with certainty is that we will see continued volatility.

Generally speaking, the market's short-term upside will likely be contained by the limited visibility in corporate profits and economic growth. By contrast, the market's short-term downside should be contained by the extreme negative sentiment readings, substantially lowered economic and market expectations and a historically aggressive public policy that is intended to address the lingering credit issues and to repair the world's weakened financial system.
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