Kass: Equities Edge Toward a Top

My bottom line is that QE 2 will have only a modest effect on the broad economy. Our largest corporations will fare better as interest rates drop and will profitably extend their debt maturities in a cheap and hospitable bond market, but, as commodities rise, some troubling consequences could emerge.

We are not on a road to the stagflation of the 1970s, but we may very well be on the road to screwflation.

Screwflation, like its first cousin stagflation, is an expression of a period of slow and uneven economic growth, but, its potential inflationary consequences have an outsized impact on a specific group. The emergence of screwflation hurts just the group that you want to protect -- namely, the middle class, a segment of the population that has already spent a decade experiencing an erosion in disposable income and a painful period (at least over the past several years) of lower stock and home prices. Importantly, quantitative easing is designed to lower real interest rates and, at the same time, raise inflation. A lower interest rate policy hurts the savings classes -- both the middle class and the elderly. And inflation in the costs of food, energy and everything else consumed (without a concomitant increase in salaries) will screw the average American who doesn't benefit from QE 2.

In summary, somebody holds the key to a self-sustaining domestic economy, but I doubt that it is a monetary maven, as some of the potential side effects of quantitative easing might be worse than the medicine. And the confidence and animal spirits that the markets have expressed since early September might just be blind faith.

The domestic economy remains in a contained recession, and, while containment efforts will continue with QE 2, the efficacy of these efforts will likely disappoint and wane.

I continue to see the risks to 2011 corporate profit and U.S. and worldwide economic growth rates to the downside. It remains likely that secular and nontraditional headwinds will produce an extended period of inconsistent and uneven growth in the years ahead, which will be difficult for both corporate managers and investment managers to navigate. Arguably, given the sharp rise in equities, the downside risks might be growing ever greater, especially if I am correct that QE 2 will be a dud.

The key to remedying today's low P/E multiples would be to apply the same amount of attention, brain power and solutions spent on short-term policy (which invariably makes things worse) on the underlying structural problems that our country faces.

But, patience, more than policy, is something that investors, politicians and others have precious little of these days.

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's daily trading diary, please click here.

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