This commentary originally appeared at 8:11 a.m. EST on Feb. 23 on Real Money Pro.
In my segment last night on "Fast Money," I explained why the technical and fundamental signs had me moving into a net short position earlier this week.
Along with Melissa Lee was Guy Adami, Karen Finerman, Pete Najarian and Ron Insana.
Let's go directly to
of the segment.
I started by expressing that there was a lot of optimism
on my last appearance on "Fast Money" when I was of the view that the
S&P 500 Index
could approach its 2007 high sometime in the second half of this year.
At the time, my view was an outlier. Less so now. Much less so.
A lot has occurred since then, including an 8% rise in the S&P -- unfortunately, to me, the near-term reward-to-risk has turned unfavorable, but my concerns run far deeper than just the fact that stocks have risen smartly.
I then broke down my concerns into the technical and the fundamental.
First, back in December investor sentiment was sour. There has been a huge change coincident with rising prices, as sideline retail cash has come in and hedge funds have expanded their net long exposures. It rarely pays to buy stocks when 85% of the S&P 500 trades above its 50-day moving average, as is the case today. Taking the opposite tack, only 3% of the S&P 100 stocks are oversold, using 14-day stochastics. Since 2004, the five prior times this happened, the market has had, on average, a drop of 4% to 5%.
Second, in a sharply advancing market (such as we have witnessed), we must be alert to divergences. There are good advances, and there are bad advances. And I see divergences aplenty. I see this as a bad advance, as it has been accompanied by a lower number of new highs, and I took issue with something that Joe "JJ" Kinahan said the previous evening on "Fast Money" -- namely, that we are seeing, on each leg higher in stock prices, volume declining as prices rise.
That's a technical warning signal that the advance is growing more selective and that it is maturing; it is not a sign of market strength.
Finally, we have developing weakness in financials the
Financial Select Sector SPDR
closed at Wednesday's intraday low, and, importantly, the lagging transport index (something that Steve Cortes has highlighted recently) is another worrisome indicator.
To me, all of these technical observations are examples of classic divergences in an advancing market.
We had little time to discuss the important fundamental issues that have caused me to make the shift from net long to net short, but I will expand here.
For the markets to rally to new all-time highs this year (as
and others have recently opined on), a lot has to go right. It will require a revival of animal spirits driving valuations back to over 15x earnings, in line with history. It's not an impossible feat, but not likely based on the residue of issues from the last cycle that has produced a fragile recovery, our fiscal imbalances (local, state and federal) and the structural disequilibrium in the jobs market (among other factors). In addition, over the past six weeks, the economic, geopolitical and political footings have weakened:
- The price of oil is now over $106 a barrel -- this is a tax on the consumer and a potential threat to corporate profit margins and profits. (The breakeven on 10-year TIPS are now at a seven-month high, indicating increased inflation concerns.)
- Broadening geopolitcal risk in the Middle East.
- Emerging markets are slowing down markedly. (Tuesday night's China HSBC flash PMI was not encouraging and indicates below-trend-line growth for that region.)
- Europe is slowing -- again. (Tuesday night's Eurozone PMI manufacturing shrunk to 49.7 in February after a rebound to 50.4 in January, well below the consensus of 50.8. Today the EU lowered 2012 real growth forecasts for the region.)
- Continued reliance on monetary policy (and more cowbell) to solve our problems, meanwhile more effective and enduring pro-growth fiscal policy is neglected (as the word "compromise" has apparently no place in Washington, D.C.).
- The administration has offered an unrealistic U.S. budget that is dependent on assumptions that would embarrass the tooth fairy.
- Finally, the Republican Party has appeared to snatch defeat from the jaws of victory. Investors understandably view Republicans as market- and business-friendly. Mitt Romney's odds of getting the Republican presidential nomination has dropped from over 90% to close to 70%, while Obama's odds of regaining the presidency has moved from only 50% to 60% since year-end.
Pete Najarian asked me about the relevance of exchange-based volume, as the options market (based on his analysis) has increased in volume. I told Pete I was not willing to dismiss the importance of exchange-based volume and I would reemphasize the first chart above, which highlights my concern that volume has receded on each of the recent three major rallies since 2009.
My old buddy/pal/friend Ron Insana said my big-picture issues might have a bearing on a larger market drop over time but not on the near-term outlook. I think he misunderstood my points, though. Remember the show is "Fast Money" (not "Slow Money") -- viewers are more interested in the short-term market outlook, which I was addressing. In addition, my intention was to say that the market could decline at least 4% to 5% based on a combination of fundamental and technical considerations. I explained that my reference to the big-picture problems (fiscal imbalances, disequilibrium in labor market and the residue of other issues from last cycle) was an explanation why, unless fundies were perfect (they are not!) historic valuations of 15x seems possible but improbable. They were not reasons or references to a near-term correction.
Moreover, I would say to Ron that I don't view a 4% to 5% drop in the indices as trivial. After all, in that magnitude of a decline, many stocks will fall 10% or more.
At the time of publication, Kass and/or his funds were short SPY common and calls, although holdings can change at any time.
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.