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Kass: Too Early to Expect a Turnaround

This blog post originally appeared on RealMoney Silver on Dec. 22 at 7:59 a.m. EST.

While I am feeling fairly confident about the likelihood that the U.S. equity market has bottomed, this morning, let me play the devil's advocate in asking what the chances are that current fiscal and monetary policies fail to take hold and remedy a domestic economy in a deepening descent?

I am well aware that my observations in today's opening missive are not new revelations -- I have been writing about them for three years! -- but they are significant enough to consider the possibility that quantitative easing will only be partially successful (or even could fail). The highlighted consumer, corporate and financial headwinds below suggest that not only will an economic recovery be pushed out further than most observers expect but also, when the recovery does come, it will be muted by most historic comparisons. It follows that the recovery in the capital markets might also be slower to respond to massive and unconventional stimuli.

    1. Consumer debtloads remain elevated. Confidence is shot as the consumers' two most important assets (housing and stocks) have experienced an unprecedented diminution in value. While aggressive government purchases of mortgage-backed securities and quantitative easing are lowering the lower mortgage rate, allowing some to refinance or even buy a new home, it's still a credit issue for most who will fail to qualify under the more stringent credit parameters that exist today. Moreover, the profound loss of confidence coupled with accelerating job losses do not suggest to me that people will go out, buy new homes and spend. Stated simply, policy (unconventional liquefying of intermediaries and lower interest rates) will not force people to transition from being risk-averse to taking risk.

    2. Corporations (both large and small) are now risk-averse for obvious reasons, the most important of which is the credit shock. I don't buy the argument that the largest corporations are flush. Yes, inventories are lean, and they better be. As to the notion that these corporations are well positioned, does that include General Electric (GE), a bogus AAA credit that could announce that it just is going to let its GE Capital business run off to save cash and liquefy its balance sheet? Does that include corporations that are now facing sudden and conspicuous drops in demand for their goods and services?

    3. As to the financials, we have just begun to witness the deterioration in the consumer and corporate loan cycles, raising the specter of another round of writedowns and possible capital raises. Regardless of policy, the pendulum of credit availability seems to be moving to the opposite extreme than what existed four years ago.

    4. The argument being made today is that policy is "forcing investors out on the risk curve." Yes, the textbooks would say so, but after equities have halved and in a world that has gone Madoff (and Dreier), maybe it's not so quickly as history would suggest. Frankly, there are no historic precedents to the depth and rapidity of the business cycle's decline, the magnitude of stock prices dropping and credit seizing up. It was different this time, and we must respect the legacy and the long tail of the abusive use of credit by both lenders and borrowers.

The bottom line is that while I am feeling pretty, pretty, pretty, pretty good that the stock market has bottomed and while there are continuing signs of improving credit conditions, it is far too early to expect to see a stabilizing/improving economic landscape. Investor enthusiasm should be curbed and tempered by our present economic reality, the legacy and aftermath of an abusive attitude on the part of borrowers and lenders toward debt/credit and based on the continued body blows to investor confidence.

From my perch, the stock market remains in a fairly broad trading range of plus/minus 10% to 15% until the foreseeable future.


Doug Kass is the author of The Edge, a blog on RealMoney Silver that features real-time shorting opportunities on the market.


Know What You Own: General Electric operates in the conglomerates industry, and some of the other stocks in its field include United Technologies (UTX), 3M (MMM), Danaher (DHR), PPG Industries (PPG), Cooper Industries (CBE) and Textron (TXT). For more on the value of knowing what you own, visit TheStreet.com's Investing A-to-Z section.

Stock quotes in this article: GE, UTX, DHR 
At the time of publication, Kass and/or his funds were short General Electric and Danaher, 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 Long/Short LP.

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