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Kass: Sell Rosh Hashanah

Uh oh.

Grandma Koufax put it more succinctly and visually than I ever could when she used to say, "Dougie, you can't make chicken salad out of chicken scat" (only she didn't say scat). I will stick with my Grandma, who was an exceptional investor for nearly 80 years.

At best, I expect QE3 to have only a muted positive impact on the domestic real economy. At worst, QE3 could produce more damage than good.

I believe the market's lifeblood and its ultimate fair market valuation importantly lie with the direction of U.S. corporate profits. As I mentioned previously, third quarter 2012 will represent the first drop in S&P earnings in three years. But more important to investors today than the current level of profits is the future trend in profits. The bottom-up consensus for 2013 S&P profit growth is for gains of at least 10%, while the top-down estimates are at about 5% growth. But given the limited effect QE3 will have on the U.S. economy, the current modest and slowing +3.5% nominal U.S. GDP (which implies punk corporate top-line sales), the threat of a fiscal cliff in the U.S. at year-end, 55-year highs in corporate profit margins, declining and uncertain Chinese economic growth, a deepening recession in Europe (which will likely continue further into next year) and the universal signs of a slowdown in manufacturing activity in nearly every other region in the world, an outlier expectation of a decline in corporate profits of as much as 5% is more likely for next year.

I wanted to add a quick mention of the extreme investor optimism that has emerged, especially after the Fed's announcement on Thursday. It should be emphasized that, unlike the introduction of QE3 in this month, during a time when share prices are overbought and at near-five-year highs, QE1 (November 2008) and QE2 (August 2010) were introduced with the market extremely oversold and testing yearly lows. Sentiment readings, not surprisingly, are elevated today. As an example, on Friday the five-day CBOE put/call ratio was at its lowest level since July 2011 -- this reading preceded a 20%-plus three-month correction that started in the next month and ended in October of last year.

In summary, I believe I have every rational reason to be cautious and suspicious of the recent market gains.
Doug Kass is the president of Seabreeze Partners Management Inc. Under no circumstances does this information represent a recommendation to buy, sell or hold any security.

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