This blog post originally appeared on RealMoney Silver on April 25 at 8:35 a.m. EDT.
"It's the American economic boom. The greatest story never told." -- Larry Kudlow, "The Kudlow Report" (2008)
In 2007 and early 2008, I warned that the impact of unregulated, unwieldy and unpriced derivatives plus a speculative blowoff in residential home prices around the world produced a toxic combination that would bring down stock markets and economies worldwide.
There were few of us (naysayers) with this view back then -- in fact, you could count them on two hands, with Bill Fleckenstein, Nouriel Roubini, Barry Ritholtz, Josh Rosner, John Mauldin, Dave Rosenberg, Meredith Whitney and Gary Shilling among the only disbelievers who sounded the foreboding scream of skepticism and economic warning.
I remember being one of those standard-bearers of pessimism in multiple business media platforms -- on "The Kudlow Report," when guest hosting "Squawk Box" and when interviewed by Alan Abelson in
. At times, even to myself, I sounded like a didactic Cassandra -- after all, stocks were marching ever higher in an orderly fashion, crushing the shorts who stuck out like the proverbial sore thumb.
Back then, on Sir Larry Kudlow's "The Kudlow Report," I debated the uber bulls, Don Luskin, Dr. Bob, Brian Wesbury, Jim Paulsen and many others. Good people and hardworking analysts/economists who were no doubt nice to their mothers and certain in their views.
During that period leading up to the Great Decession of 2008-2009, my friend/buddy/pal, Larry Kudlow, taking a cue from wordsmith Peggy Noonan, coined a wonderfully crafted phrase, calling the U.S. economy "the greatest story never told."
To me, at that time, I saw a domestic economy that appeared healthy but with foundations that were cracking. At odds with Larry, I adopted the conflicting phrase "the greatest story ever sold."
Here is what I wrote on The Edge (my
trading diary) in early-March 2008 column "The Greatest Story Ever Sold?" after an appearance on "The Kudlow Report":
Until late 2007, a long habit of not thinking that anything could go wrong in the stock market had given equities and the U.S. economy the superficial appearance that all was right. It seemed as if almost every market plunge was seen as a buying opportunity by investors. The dependability and pattern of an immediate market recovery that accompanied every market dip, however, similar to South Pacific's Bloody Mary's incessant happy talk, might be in the process of changing.This time might be different as a protracted period of nonsensical (and often nondocumented) credit/debt creation might have gone too far, as evidenced by the current waves of involuntary deleveraging of all sorts of overvalued assets. For almost three years, The Edge has emphasized that an unprecedented collapse in housing prices would have a profound impact on credit and would expose the financial follies and leverage at the world's leading banks and brokerages. I previously wrote that investors will only learn who has been swimming naked when the (credit) tide goes out.As Warren Buffett spelled out in Berkshire Hathaway's (BRK.A) - Get Report/ (BRK.B) - Get Report 2007 Annual Report, "What we are witnessing at some of our largest financial institutions is an ugly sight." The economic dependency on the unregulated growth of derivatives and the threats accompanying the rapid expansion of credit and debt have raised the specter that an unknowable amount of risk now permeates the world's financial system, as the peeling of the credit onion has yielded uncommon discovery month after month. One week, the problem lies in subprime; then, it surfaces in leveraged loans; then, in adjustable rate preferreds; and, in the most recent week, problems have arisen in the traditionally safe municipal bond markets -- and so on and so forth.I remain deeply skeptical that the domestic economy will continue to thrive given the complexity and extent of U.S. economic and credit issues. The Edge continues to argue that the cost of avoiding a recession might be greater than the cost of enduring a recession. Few have agreed, as calls for monetary shock and awe have been plentiful. Unfortunately, the unintended consequences of re-inflating the domestic economy is seen vividly in the rising price of oil ($100 per barrel), near $1,000 per ounce gold (14 record highs in 2008), spikes in the price of other hard and soft commodities and in an unending weakness in the U.S. dollar. The latter concern, depreciation of our currency, remains the most disturbing result of undisciplined U.S. monetary and fiscal policy. Over this weekend, Buffett expressed his thoughts on the subject of the U.S. dollar in his annual letter to shareholders of Berkshire Hathaway: "Our $2 billion daily of force-fed dollars to the rest of the world may produce global indigestion of an unpleasant sort." I see Fed policy of lowering interest rates as pushing on a string. Lower interest rates will not likely have the desired economic results: After dropping for four consecutive months, we would not be surprised if the markets regained their footing in the short term. While it is too early to be certain whether the current bear market is in the process of testing January's SocGen market bottom or is embarking on another leg down, I favor the former. Nevertheless, intermediate-term concerns are intensifying in their scope and depth. The following expected headwinds will likely result in a more difficult market backdrop over the next few years and could provide an extended period of substandard returns:
- It won't make banks lend, even despite a more positively sloping yield curve.
- It won't make builders build, even despite the possibility of lower mortgage rates.
- It won't make consumers spend, as they are levered and spent-up.
- It won't make businesses expand, as confidence ebbs and corporate margins and profits suffer.
- We are at recession's doorstep. The ECRI's leading indicators signal unambiguously that the U.S. economy is at the doorstep of a recession; the series is at the lowest level since 1980.
- Credit conditions are getting worse. The credit markets have not strengthened against the backdrop of improving equities since the January 2008 low. In fact, although the yield curve has steepened, junk bond spreads and broker credit default swap spreads have worsened while the turmoil continues to move up the ladder of credit.
- The powers that be fail to address the housing depression and the adverse credit markets. Forty years ago on "Meet The Press," William Buckley, the founder of the modern conservative movement, had some comments that have applicability to America's leadership today (though he had a different idea of the party he was scorning.) when he said, "I would rather be governed by the first 2,000 names in the Boston telephone directory than by the two thousand people on the faculty of Harvard University." A timid and unimaginative Executive Branch and Treasury Department have failed to address the housing and credit industry's woes. Moreover, the Federal Reserve is behaving like Milton Friedman's "fool in the shower."
- Inflation no longer remains well-anchored. Energy and food prices remain stubbornly high and, according to recent government releases, are beginning to seep into core prices.
- Profit margins are eroding. Corporate profit margins, the most mean-regressing series in finance, have begun to recede in the face of decelerating sales growth and cost pressures.
- Economic decoupling is proving to be an illusion. Increasingly, non-U.S. economies are feeling our domestic weakness.
- The U.S. dollar is in a free fall. Our currency seems to drop to new lows on a daily basis, putting pressure on European economies (and elsewhere), which could, in time, raise the specter of trade protectionism.
- The hedge fund industry is beginning to contract. The dominant investor of the last decade (hedge funds) is contracting around the globe. Outflows and forced liquidations could prove challenging to the demand/supply equation for stocks and credit instruments -- especially considering the degree of leverage that has been employed.
- There are threats on the political spectrum. The continued strength of Senator Obama's candidacy raises the increased possibility of higher tax rates for individuals and corporations and, again, the threat of trade protectionism.
- Technical signs are eroding. While there are some emerging technical positives -- the 200 new lows on Friday are still well below the 1,100-plus new lows at January's SocGen market bottom, and put/call ratios, around 1.25, are now at the highest level since that time -- the market remains technically challenged.
Eventually, I and the others were proven correct; we were right for the right reasons, and we did well for our clients. Those most convicted, such as hedge-hogger John Paulson, made billions of dollars shorting the markets, but most money managers lost 40%-60% of their clients' money
"Time heals what reason cannot." -- Seneca
As it is said, time heals everything, as today many of those circa 2007-2008 bulls have been reincarnated and, despite serious setbacks two to three years ago, have morphed back into astonishingly confident and prominent cheerleaders -- almost as if their major-league investment boner never even occurred.
On that score, here is an interesting (and true anecdote) that underscores some of the lessons of the past.
As I write today's opening missive, I am preparing a lecture for Dr. David Stowell's course on hedge funds at the Kellogg School at Northwestern University in Evanston, Ill., later today. One of the recommended books in Dr. Stowell's course is Barton Biggs'
. Over the course of the last 20 years or so, I have often inserted in my library of books holiday cards, letters, newspaper articles, research reports -- anything I thought I might find interesting years later. One such insert in Barton's book, which I took on the plane with me to Northwestern, was a strategy piece by one of the most vocal bulls today who got the 2007-2008 period entirely wrong. In his report, dated February 2008, was a lengthy (and certain) analysis in support of his 2008
earnings forecast of $95 a share, a number that proved to be preposterously wrong! That same strategist, unrepentant of his prior and bold mistakes, today has the same $95-a-share estimate for 2011 and is highly confident with his $105-a-share forecast for 2012!
Let's now fast-forward to April 2011.
With every Treasury
and with every uptick in the world's stock markets, investors are building up their stock portfolios with a false sense of security as their optimism blossoms under the encouragement of the strongest of market trends.
Even the most negative commentators are in hibernation (most of them in the gold cave anticipating the tragic demise of the U.S. dollar) for fear of being ridiculed or trampled on by the crowd, which appears (similar to in 2007) to have heavily outsmarted by the remnants.
History doesn't repeat itself ... at best it sometimes rhymes." -- Mark Twain
In many ways, today's problems -- namely, structural unemployment, the
and fiscal imbalances (around the world) -- are even more serious and more difficult to resolve than its recent predecessors.
It is clear to this observer that the U.S. economy's forward momentum peaked in February as first-quarter 2011 growth, expected to be +3.5% 90 days ago, looks closer to +1.5% now. Most notably, higher costs for life's necessities (food, gasoline, etc.) have begun to sap the purchasing power of an already vulnerable consumer. Meanwhile, home prices are exhibiting no signs of recovery and, arguably, have begun to experience a second dip. In contrast to cash-rich large corporations, small businesses continue to suffer, as evidenced by low readings in confidence surveys. Domestic loan growth is still weak and our local and state governments are preparing for European-style austerity (along with the implementation of higher marginal tax rates). Over there (in Europe), central banks are tightening, and austerity measures are being implemented. In Japan, the natural disaster has created dislocations and a material slowdown in growth. The Middle East remains a powder keg and a risk to worldwide growth. And even in China, growth is decelerating under the pressure of a series of tightenings aimed at lower inflation.
At best, subpar growth looms on the domestic economy's horizon; at worst, a double-dip is still possible.
In this past Sunday's
New York Times
op-ed David Stockman
the most serious (deficit) challenge clearly:
It is obvious that the nation's desperate fiscal condition requires higher taxes on the middle class, not just the richest 2%. Likewise, entitlement reform requires means-testing the giant Social Security and Medicare programs, not merely squeezing the far smaller safety net in areas like Medicaid and food stamps.Unfortunately, in proposing tax increases only for the very rich, President Obama has denied the first of these fiscal truths, while Representative Paul D. Ryan, the chairman of the House Budget Committee, has contradicted the second by putting the entire burden of entitlement reform on the poor. The resulting squabble is not only deepening the fiscal stalemate, but also bringing us dangerously close to class war.This lamentable prospect is deeply grounded in the policy-driven transformation of the economy during recent decades that has shifted income and wealth to the top of the economic ladder. While not the stated objective of policy, this reverse Robin Hood outcome cannot be gainsaid: the share of wealth held by the top 1% of households has risen to 35% from 21% since 1979, while their share of income has more than doubled to around 20%.The culprit here was the combination of ultralow rates of interest at the Federal Reserve and ultralow rates of taxation on capital gains. The former destroyed the nation's capital markets, fueling huge growth in household and business debt, serial asset bubbles and endless leveraged speculation in equities, commodities, currencies and other assets.-- David Stockman, "The Bipartisan March to Fiscal Madness" ( The New York Times)
It feels like deja vu all over again.
Doug Kass writes daily for
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At the time of publication, Kass and/or his funds were long BRK.B, 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.