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Kass: The End of the Trend

This blog post originally appeared on RealMoney Silver on March 10 at 8:45 a.m. EST.

"A long sea implies a uniform and steady motion of long and extensive waves; on the contrary, a short sea is when they run irregularly, broken, and interrupted; so as frequently to burst over a vessel's side or quarter."

-- William Falconer

My "Fast Money" segment last night dealt with the following subject: why 2011 will be a trading market, not a buy-and-hold market, and how to profit from it.

I start by making the point that it is my view that the trending market of the past two years is about to become a trendless market.

I continue to see a sideways market and expect the S&P 500 to likely be roughly flat for the full year, which implies about 5% of risk from current levels.

Volatility is back. Indeed, the VIX has penetrated the downtrend line that has existed since July 2010.

The climate for risk assets is changing -- and not for the better.

I reminded the "Fast Money" gang that during my appearance last Wednesday, I said that 2011 will be a year in which opportunistic traders will likely outperform the buy-and-hold crowd.

I feel strongly that this will be the case.

My view is that Mr. Market will have a limited memory from day to day this year and that investors will be held hostage to a number of uncertainties that will produce a frustrating, uneven and trendless U.S. stock market.

Here are five factors that I think will contribute to a trendless market -- bad for investors, good for traders:

  1. Geopolitical worries. As Tom Friedman told us on "Meet The Press" on Sunday and George Will wrote in his Washington Post op-ed piece on Tuesday, what is happening in the Middle East is a continuing drama that will not have an immediate resolution. The situation is hard to handicap, and it presents numerous commodity, economic and profit outcomes, and that uncertainty will hold investors, and even policymakers, at bay for some time.
  2. A dysfunctional U.S. government. The pros who monitor our politicians in Washington, D.C., such as CNBC contributor Greg Valliere, share similar conclusions -- namely, that the government will continue to operate through a series of stop-gap measures and a compromise by May seems likely. (So, there will be budget uncertainty for several months.) There will be a spending cut on the order of $25 billion, which is far less than the Republicans and the bond market hope for, but, as we move toward the November 2012 elections, the promise of compromise will disappear, serving to limit the administration's and the opposing party's initiatives. Considering the enormity of the due bills emerging, investors will be disappointed, uncertain and unwilling to commit for the long haul. Meanwhile, the bond vigilantes are poised to be a destabilizing market force in the months ahead. (We already have seen a bottom in interest rates and inflation rates; the upside ceiling is unknown thus more uncertainty.)
  3. The economy. Since neither corporate tax reform nor an intelligent energy policy will be forthcoming, the continuing threat of a dysfunctional Washington will negatively impact both business and investor confidence in spending.
  4. Eroding investor sentiment. If the market becomes, as I suspect, more volatile and investors become less convicted in a trending market, individual investors will become increasingly spooked -- it is almost in a self-fulfilling prophecy. So, hopes of large inflows into domestic equity funds might be fanciful in light of the recent body blows of higher costs of necessities, slowing wage growth -- remember the average workweek declined by 0.1 hours and the average hourly earnings experienced no change in Friday's job report -- and the still-fresh recollection of the 2008 investment scare -- will contribute to more volatility and lack of trend and direction. (Already retail inflows have abruptly stopped in the face of Middle East tension and rising oil prices.) If no money is coming into equity funds, the investment backdrop is like a big bathtub, with water sloshing around from sector to sector. It becomes a zero-sum game. (I would add that the results this week of the most recent Gallup Confidence poll indicate a sharp drop in confidence in the face of Middle East unrest, continuing European sovereign risk and rising energy prices.)
  5. Tail risk. Thus far, tail risks in housing, sovereign debt problems, new tech concerns and fear of the Fed's have weighed on the world's economies and investments. The specter of other tail risks remains; we just don't know where they exist and what they are. But the black swans of tail risk have occurred with such regularity that they will likely produce less investor confidence and more paranoia.
Melissa Lee asked me how my portfolio is currently structured in light of these views.

I responded that I continue to like shorts these days and plan to slowly build up my short exposure -- particularly in light of the aforementioned concerns.

So how should investors profit from a market that has not only become a market with little memory from day to day but one with little memory from hour to hour?

In the trendless market I see, one should neither chase strength nor short weakness. Rather, opportunistically buying the dips and selling the rips makes much more sense. Stay market-agnostic, and invest in very special situations with good risk/reward ratios.

I fully recognize that rotating in market sectors/groups is not for everyone. It's frustrating and unnerving when strength begets weakness and weakness begets strength. This sort of action is not confidence-building, and it's hard to have the courage to implement the strategy.

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