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False Economic Dawn; Personal Income Data: Best of Kass

NEW YORK (TheStreet) -- Doug Kass of Seabreeze Partners is known for his accurate stock market calls and keen insights into the economy, which he shares with RealMoney Pro readers in his daily trading diary.

Among his posts this past week were entries about the false economic dawn and personal income and Chicago manufacturing data.

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The False Economic Dawn
Originally published on Friday, May 31 at 8:52 a.m. EDT.

Central bank liquidity blurs the line of demarcation between economic reality and stock market euphoria.

  • First-quarter 2013 corporate profits, though slightly above consensus expectations, were of low quality, as share buybacks, lower interest expenses and lower effective tax rates and reserve reversals in the banking sector somewhat offset tepid and disappointing top-line growth. (Note: First-quarter 2013 sales were basically unchanged year over year.)
  • Top-down consensus for 2013 S&P 500 profits is $108-$109 a share. For 2014 S&P profits, consensus stands at around $115 a share. Both are too optimistic -- I am at $104 this year and $107 for next year.
  • The difference between my estimates and the (higher) consensus estimates for 2013-2014 principally reflects the vulnerability of record-high profit margins (that lie about 75% above the long-term trend) as well as slowing global economic growth.
  • The profit margin benefits from the lengthy and recent drop in interest expenses and lower effective tax rates appears over now, as interest rates are beginning to move higher and low effective corporate tax rates (and tax havens) are under scrutiny. As well, a strengthening U.S. dollar will constrain profit growth and hurt margins. Finally, it appears that the end of productivity gains is upon the corporate sector and any further firming in the jobs market might bring the early stages of some wage price inflation.
  • Slowing global economic growth is evident. In the U.S., the Richmond, Empire and Philly PMIs were weaker than expected. So was industrial production. Capital spending remains weak. Retail sales, though stronger than projected, have benefited from a pull-forward in activity, as the savings rate has plummeted down to late-2007 levels. Even the strength in housing sales and activity/turnover appears to be vulnerable, as institutional buying of homes (a plus for prices) and higher mortgage rates sow the seeds of lower affordability and pricing out first-time buyers. In Europe, the recovery seems elusive (and the OECD yesterday lowered economic growth expectations). China's growth rate is decelerating.

In summary, I have a variant view on both the corporate profit outlook and global economic growth outlook vis-a-vis consensus. My more ursine view, though ignored by the markets to date, has been supported by the recent cautious guidance by corporations during their first-quarter earnings reports and conference calls as well as by the high-frequency economic data and the recent downturn in the Citigroup (C) Surprise indices.

-- Doug Kass, "The Negative Ramifications of Changing Market Leadership" (May 30, 2013)

At the core of my ursine market view are the following points:

  • Global economic growth is slowing.
  • Corporate profits will be challenged and will not likely meet consensus expectations.
  • Valuations, not earnings expectations, have risen in 2013.
  • Structural issues will continue to produce subpar on economic and profit growth.
  • Above-historic P/E multiples are now exposed and vulnerable.
  • An "aha moment" is upon us, as the Fed is pushing on a string.

After the close Goldman Sachs (GS) released its Goldman Sachs Analyst Index (GSAI), a bottom-up assessment of business activity accumulated by the brokerage's research analysts.


The index remained weak in May -- at 43.9 this was the second-lowest reading since November 2012. The current reading implies below-trend growth in the U.S. (of about +1.5% to +2.0%).

The May GSAI coupled with the Richmond, Philadelphia and Empire manufacturing indices correspond to a deceleration in domestic economic growth. Retail sales, buoyed by a five-year-plus low in the savings rate augurs poorly for forward personal consumption expenditures. Even housing and automobile activity have begun to flatten out. Add to this, the U.S. and non-U.S. Citigroup Surprise Indices, which illustrate that high-frequency data are falling below consensus projections. Taken together, these readings form the basis for my observation that there is a widening disconnect between a challenging economic and profit cycle and relentless rising world stock markets.

The proximate cause for the blurring of the line of demarcation between economic reality and stock market euphoria remains central bank liquidity.

As expressed yesterday, outside of the U.S. things are not much rosier. Europe remains in an economic death spiral. (Note:The OECD lowered 2013-2014 growth projections on Wednesday.) Latin America is weakening. China's economic growth rate is decelerating.


The widening disconnect between economic/profit reality and rising stock prices is occurring at a time when, in the U.S., the impact of QE is diminishing. Indeed, net-net, the suppression of interest rates might now be resulting in a negative aggregate impact on growth.

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