Kass: Curbing My Enthusiasm
By Doug Kass 07/03/12 - 12:00 PM EDT
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This column originally appeared on Real Money Pro at 8:40 a.m. EDT on July 3.
NEW YORK (Real Money) -- Strategic adjustments:
- I have slightly adjusted my S&P 500 fair market value downward from 1455 to 1430 -- the market is still about 5% undervalued.
- A trading range of 1290 to 1430 seems probable for the balance of 2012.
- Against the anticipated trading range above, reward and risk remain basically in balance (70 S&P points up and 70 S&P points down).
Let's investigate what fundamental, sentiment, valuation and political changes have occurred since my last fair market value update five weeks ago.
- U.S. Economy: Deteriorating. Domestic economic data have been disappointing relative to my modest expectations. First-quarter 2012 real GDP growth came in a tad under 2%, and second-quarter 2012 real GDP growth will be challenged to match the previous quarter. We seem destined to muddle through this year, closer to 1.5% growth compared to our previous below-consensus expectation of 2.0% growth. Payroll growth seems stuck at below-consensus levels, and the rate of growth in U.S. manufacturing activity is decelerating at a more rapid pace. On the other hand, some major positives for worldwide growth include global easing, the drubbing in commodities (a tax cut to the consumer and a prop to corporate profit margins, which argues in favor of an extended period of easing) and the improvement in the U.S. housing market (the sector represents the greatest divergence in economic series relative to consensus). Business and consumer confidence, which was still elevated as recently as last month seems destined to drop in the months ahead amid EU concerns and U.S. political concerns (the fiscal cliff).
- Europe's Economy: Negative With Little Visibility. Despite some steps in a positive direction achieved at the recent Brussels meeting, a lot of structural issues and heavy lifting remain. More importantly, the bigger issues of insured bank deposits, eurobonds, fiscal integration and a larger scale for both the ESM and ESFS were not discussed in any detail. Here is the extreme negative case for the eurozone, as told by Byron Wien. This week I expect the ECB to cut its target rate by 25 basis points and its deposit rate paid on reserves by 10 basis points, in line with general expectations.
- China's Economy: Heading Toward a Hard Landing. A soft landing no longer seems to be the strong base case scenario as there are emerging question marks over the strength of the region's economy and the validity of its data.
- Corporate Profits: Consensus Forecast Is Now in Jeopardy. While only one-sixth of aggregate S&P profits come from Europe, the region's economic outlook is ambiguous at best. I am now skeptical of consensus eurozone real GDP growth expectations of a modest reduction in 2012 and a small increase in 2013. The U.S. remains the best house in a bad neighborhood: with 1.5% to 2% real GDP growth and less than 2% inflation, nominal GDP growth is likely to be a subpar 3% to 4% this year, translating to about 5% to 6% sales and profit growth. (Of course, most realtors will tell you never buy the best house in a bad neighborhood.)
- Investor Sentiment and Expectations: Still Low. Most classes of investors have de-risked, which is not surprising considering sluggish worldwide economic growth, still elevated unemployment and the ongoing eurozone crisis. Add in the JPMorgan Chase (JPM) large derivative loss and the Libor manipulation of Barclays (BCS) and other banks, and a show-me attitude will likely continue for some time. Low trading volume, dominated still by high-frequency strategies, and the absence of inflows into domestic equity funds are a reflection of investor indifference. Stated simply, stocks remain an unpopular asset class, and the reallocation out of bonds and into stocks looks to be a more distant event.
- Political: The Outlook for the November Election Remains Uncertain. The Supreme Court's healthcare decision has likely further divided our dysfunctional political leaders/parties. As a result, an August 2011-like impasse on the fiscal cliff is more likely. A potential positive to the capital markets (based on the general belief that a Republican administration will be more business- and market-friendly) is that the Republican Party is gaining some traction as compared to several months ago.