Kass: The Quant Bubble

This blog post originally appeared on RealMoney Silver on Nov. 17 at 8:04 a.m. EST.

"When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you've got to get up and dance. We're still dancing."

-- Chuck Prince, former chairman and CEO of Citigroup (told to the Financial Times on July 10, 2007).

These words resonate to me in the current investment setting as many investors and traders are assuming the most benign of economic outcomes and have begun to dance and party like it's 1999. The media's talking heads are doing their best to fuel the celebration, just as they were at DJIA 14,000 before the market crashed last year. It is also the same group of cheerleaders that was mired in depression eight short months ago.

Some, like myself, have been cautionary (and wrong) over the past few months, expressing concerns over emerging short- and intermediate-term headwinds that threaten a self-sustaining economic cycle, including the effect of the withdrawal of monetary and fiscal stimulus. Countering those concerns has been one overriding factor -- namely, the Fed's zero rate policy and curse on cash, which has already produced its desired effect of causing investors to "look over the valley" and to buy longer-dated assets (equities, bonds, commodities).

Nevertheless, there are already some more tentative economic signs emerging in housing and in confidence, and it remains my view that the real economy will disappoint in 2010. (This more downbeat assessment seemed also to have been contained in Bernanke's message yesterday.) If I am correct, equities are in the process of disconnecting from fundamentals as they soar ever higher in the face of a self-perpetuating cycle, fueled by performance-anxiety, the unwillingness to be left behind and the growing consensus view of 3%-plus GDP growth and $80 a share in S&P 500 earnings in 2010.