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Kass: A Wolf in Sheep's Clothing

This column originally appeared on Real Money Pro at 8:41 a.m. EST on Jan. 14.

NEW YORK (Real Money) --

"Beware of false prophets, which come to you in sheep's clothing, but inwardly they are ravening wolves."

-- The Holy Bible, Matt. 7:15 (King James Version)

Markets move based on how events transpire relative to consensus expectations, and it is my view that many commonly held and more upbeat expectations for 2013 are too optimistic -- perhaps substantially so.

To be sure, Mr. Market's momentum from the end of 2012 and year-to-date 2013 has been impressive, but Mr. Market is often fickle and the wolf could emerge out of the sheep's clothing.

With higher share prices has come a degree of investor optimism that is all too often associated with previous tops.

Most recently, the failure of the fiscal cliff debate to accomplish much of anything has been ignored by investors. I am now convinced that hyper-partisanship will prevent meaningful budget cutting legislation in the months ahead.

This is a profound negative, as it relates to our economy and our investments.

From my perch, the current degree of bullishness (among other reasons) is founded on the notions that:

  • there is a global monetary put that limits the market's downside;
  • fund flows will move out of bonds and into stocks (and reverse the trend in place since 2007);
  • equities are cheap relative to interest rates;
  • the economic recovery is healthy and self-sustaining;
  • the growth in corporate profits will continue apace;
  • corporate balance sheets are pristine; and
  • the housing market will have an above-average 2013 (capable of offsetting some of the Washington induced drag).

While some of these factors have merit, I believe, nonetheless, that there is less than meets the eye to the current equity market advance.

Market participants, for now, are ignoring conspicuous headwinds and rationalizing the irrational.

So, I wanted to start the week by describing what I see as the most powerful headwinds and suggest that the high for S&P 500 in 2013 might be accomplished in the first two weeks of the year.

An Aging Advance

The economic recovery is aging (it is now four years old), and the bull market is maturing (of a similar age). These advances are typical of the life of the previous ones -- both in terms of duration and magnitude. In terms of economic growth, consider that, according to Zero Hedge, fourth-quarter 2012 real GDP estimates were ratcheted down last week:

  • Goldman Sachs reduced from +1.8% to +1.3%.
  • JPMorgan has gone from +1.5% to +0.8%.
  • RBS decreased from +1.5% to +0.7%.
  • Nomura went from +2% to +1.3%.

Unsustainable Fiscal Policy

The U.S. is running trillions of dollars in deficits while maintaining zero interest rates -- these are unsustainable policy strategies. The inevitable reversals of these policies will undoubtedly result in slower growth, rising interest rates and less attractive valuations.

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