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Kass: Sell Rosh Hashanah

This column originally appeared on Real Money Pro at 8:05 a.m. EDT on Sept. 17.

NEW YORK ( Real Money) -- Over the past four months or so, as the markets approached and sliced through my fair market valuation of 1390 on the S&P 500, I have been moving toward an underinvested or net short position based on:

  • an out-of-consensus, negative and what I had thought was a realistic view of the world's economies;
  • a deteriorating outlook for corporate profits;
  • somewhat stretched valuations, given the unique structural headwinds; and
  • other exogenous risks, including but not excluded to the world's geopolitical temperature was rising.

While my fundamental concerns have generally proven accurate, my investment view and positioning have been wrong, as the markets have climbed in an almost uninterrupted manner since June.

On Friday, I suggested going go over a checklist when things go differently than one expects in the market. Below are the basic tenets of this process:

  • Most importantly, spend some time objectively reevaluating your investment thesis.
  • Be honest with yourself in challenging that thesis.
  • If conditions have changed (which they have not), change your investment strategy.
  • Seek counsel from smart investors you know and sit down and discuss your thesis and get his/her feedback.
  • Take 10 deep breaths and do nothing for a while. Similar to Being There's Chauncey Gardiner, just sit there and observe.
  • Stay balanced emotionally, and don't press your investment positions.
  • Do not double down or average up until some time elapses and you have enough time to settle down, analyze your positions again and, again, get input from others.
  • Finally, if you conclude that your current investment position is not wrong-footed, do not be dissuaded, and stand firm in your view.

I have concluded this exercise and stand unambiguously behind my relatively negative and variant market view. Economic data (in the U.S., Europe and China) is coming in weaker than general expectations, third-quarter 2012 earnings will likely show the first decline since 2009, and we expect disappointing guidance ahead given the slowdown in worldwide manufacturing activity. Moreover, inflation expectations are rising, and geopolitical risks are multiplying.

Stated simply, the investment environment is growing more dangerous, as the world's economies and profit outlooks are weakening just as valuations are expanding -- a potentially toxic cocktail.

Recently, the anticipation (and realization) of more global easing has been the proximate reason for the sharp rise in equities around the world.

I have already discussed the five myths of easing, but I wanted to expand a bit on my reaction to the Fed's actions last Thursday.

A global monetary put is seen as a shield that protects risk assets, especially stocks, but it is only a protective put if more easing has a substantive impact on the real economy by improving aggregate demand, which would be expressed in more hirings, expanded capital spending, rising consumer spending and an improving housing market.

The absence of liquidity and the level of interest rates are not what ail the world's economies -- rather, it is the pain of deleveraging and austerity (which has only just started in Europe) and the neglected structural headwinds (in the U.S. jobs market and with regard to sovereign fiscal responsibility) that represent the true challenges to growth in the years ahead. Until these headwinds are dealt with, there is little room for expansion in P/E multiples, and there exists potential downside to valuations.

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