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Kass: The Loss of Market Innocence

I opined that the interest rate cliff was what investors and traders should be worried about, even more than the much-feared fiscal cliff.

Finally, I advised that there was ample evidence (second-quarter 2013 estimated real GDP of only +1.8%) that the Fed was pushing on a string and that when investors understood that condition, markets faced an "aha moment."

I concluded that as the market ramped, the reward vs. risk equation had meaningfully deteriorated. Leadership changes, I suggested, were occurring in a market whose character and complexion was changing -- this changing terrain has historically and typically provided a forceful market warning.

I projected that volatility would emerge out of complacency and that most investors, depending on their time frames, should err on the side of conservatism by expanding cash reserves and by keeping trading/investing positions smaller than usual.

I favored ProShares UltraShort Russell2000 (TWM) over iShares Russell 2000 Index Fund (IWM) and preferred being short SPDR S&P 500 ETF Trust (SPY) to being long.

And I emphasized that trading sardines (opportunistically) would become my investment mantra over eating (and investing in) sardines over the balance of 2013.

"When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you've got to get up and dance. We're still dancing."

-- Former Citigroup (C - Get Report) CEO Chuck Prince (2007)

My concerns were dismissed by the markets.

Despite no improvement in the consensus corporate profit outlook, the P/E multiples of the S&P forged ever-higher, starting the year at 13.7x and exceeding 16x a week ago. (Note: It is now down to 15x.)

Even some of the most strident bears recently turned bullish in an apparent acquiescence to the market's nearly uninterrupted run-up. Most conspicuous in a bearish-to-bullish transformation has been Dr. Nouriel Roubini. Gluskin Sheff's David Rosenberg even pulled in his ursine outlook. So did many others.

Hedge funds, benefiting from the highly profitable (but levered) carried trade, took their net long exposure to multiyear highs, and retail investors slowly but deliberately and consistently added to their investments in domestic equity funds.

Meanwhile, a generational low in interest rates took 10-year yields to 1.60% (as recently as early May), as investors grew confident that the Fed would be bond buyers ad infinitum.

By late May, I was so concerned that I sold out of all the equities I purchased back in 2009 at or near the generational bottom.

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