This blog post originally appeared on RealMoney Silver on Nov. 3 at 9:35 a.m. EST.
Last night, I was on a segment with Melissa Lee and
"Fast Money" team. As always, I had a lot of fun doing it.
Each segment of "Fast Money" lasts only about five or six minutes. The pace is quick, almost staccato-like, and there is a time limit to how much one's arguments can be fully explained in order to support one's market conclusions.
I thought instead of summarizing my appearance, as I customarily do, I would expand upon the points I made on the show.
For those interested in watching the abridged, "Cliff Notes" version,
of last night's show.
I started the show by saying that the investment mosaic always contains positives and negatives. The job we have is to figure out which factors will dominate and for how long a period of time they will serve as an influence.
So I had some good news and some bad news last night.
Not surprisingly, I started out first with the bad news because I believe that, over the short term, the negatives will dominate the market landscape.
Like my buddy/friend/pal, the handsome Guy Adami, I am currently dating "Debbie Downer."
America is about to experience a transformation from a nation with debt growing faster than incomes to a nation in which incomes will grow faster than debt. And it's not because incomes are growing especially quickly. They are not; they are trending lower. It is because of the expected large contraction of consumer debt, and the great debt unwind is the obvious byproduct of the credit crunch just passed.
That's why on last Monday's "Fast Money," I
that a hard correction of 5% to 12% from the highs could be ahead of us because the state of the consumer is different this time. Remember, on the week-ago show, I doubted the sustainability of the economic recovery. I felt that investors would look right through the better-than-expected third-quarter GDP print that was so government-dependent and also, upon further thought, would look through the
, which were off of
by corporations' investor relations departments.
If we look at past cycles, businesses have consistently been the driver of consumer incomes and spending. I learned in my economics classes at Wharton (like Karen Finerman) that this phenomenon is known as
. Say argued:
against claims that business was suffering because people did not have enough money and more money should be printed; and
that the power to purchase could be increased only by more production.
But -- and this is the big BUT -- over the last century, the consumer was in far better health than today.
Consider the following facts:
- In the past, corporations didn't engage in the draconian cost-cutting that they have embarked on in the past several years.
- Globalization wasn't the mainstay condition that it is currently, so previously we didn't see the wage deflation and the magnitude of the decline in disposable incomes present today.
- Finally, consumers were not as tightly wound and leveraged in any of the previous cycles. Just look at the record level of household debt relative to incomes that exists today.
As a result of the above factors (and others), the U.S. currently has 10% unemployment, and if you count in part-time workers that can't get full-time jobs and those that have given up looking, the number almost doubles to one-fifth of all Americans. The consumer is in dire straits, and, for the first time in history, it is the consumer that is going to drive business' growth, expansion plans and confidence, not visa versa.
Sorry, monetarists, Say's Law might be dead.
To me, the question to be answered is this: How fast will the economic backslide be while the
and the government are still providing the seeds for growth in the form of generational low interest rates and massive fiscal stimulus, and what will the impact be when we see a withdrawal of that stimulus?
I don't have the answers, but I am certain that the consumer will serve as a brake to growth. Americans are anxious. As I said last week on "Fast Money," the aspirational consumer who supported the consumption binge that we have taken for granted is going the way of the dodo bird. Instead, many could revert to a post-Depression legacy, which we recall was embraced by many of our parents, of simply trying to maintain the status quo.
And a small downtick in jobs claims won't change the consumer's fate or alter it as a headwind to growth. In all likelihood, the "
" will become evident in the quarters ahead as businesses and corporate profit expectations will disappoint and be tested under the weight of lower personal consumption expenditures and higher savings rates.
So, what is the outcome of all this?
The more productive American industry is and the greater the perception that corporations are taking a larger piece of the profit pie from the average American, the more that will be asked from corporations and the wealthy in a growing tidal wave of populism.
It is why, besides an exposed consumer, the weight of substantially higher local, state and federal tax rates remains prominent in the bearish case. Both of these factors will be P/E deflators.
On last week's show, I highlighted some troubling technicals, such as the rollover in transports and the reduced number of stocks above their 26-week moving average, as well as the lower new highs on the
As we all know, it's how markets react to news that is important; sometimes the reaction is even more important than the news itself.
Recent market advances have been featured by far less overbought readings, and the market declines of late have been showing deeper oversolds. In fact, the latest rally of two weeks ago has exhibited the weakest short-term momentum in months and the broadest oversold since the recovery's start.
Financial stocks, which were the lifeblood to the market's rally, have lagged since September and have reached new relative strength lows in last week's reaction. Small caps and technology stocks have also lost their momentum as large-cap quality stocks have improved. Helene Meisler
in her column today.
This sort of action is a typical feature in a maturing bull move. This is a clear signal that the market's health is changing -- and not for the better.
The Market Positives
Now for the good news:
- Unlike most other asset classes (commodities, real estate, etc.), stocks were never overly exploited in this cycle, so valuations are not stretched, even despite the sharp rise from March. The S&P 500 sells at only about 14.5 times normalized earnings or about 2.5 multiple points less than its historical averages and compares to an average P/E multiple of around 19.5 times, which is historically with markets when inflation is subdued (under 2%).
- Most investors already recognize that the economic recovery in 2010-2011 will pale in comparison against other recoveries. It is now accepted that unemployment will be elevated, consumer debt loads will be a drag on growth and that confidence will stay deflated.
- We are now in the sweet spot in the profit cycle. Corporate profit margins have been maintained at levels far higher than the bearish cabal thought possible and are well above previous recessions.
- Inflation and inflationary expectations are subdued.
- The Fed is far more aggressive in its monetary policy than in previous cycles. It has put a curse on cash.
- Corporate balance sheets are in an excellent position. Companies are generating record free cash flow and have more cash as a percentage of assets than in any other time over the past 40 years.
My Market View
In summary, I said that I was sticking to the forecast I made on my previous appearance a week ago. I still expect a 5% to 12% drop from the highs. For the reasons above, I see the decline being contained, and once we get into a real short-term oversold later this month or in early December, we could get a classical year-end rally, but that rally will not likely get through the previous highs.
Questions and Answers
In response to Guy Adami's question about whether I was more scared going ahead than a I have been in the past, I said that after the anticipated year-end rally, 2010 is likely to be challenging, which is unlike the opinion of many of the guests that I respect that have recently been on the show with more optimistic forecasts (Rich Bernstein, Byron Wien and Barton Biggs, etc.). I don't see the start of a self-sustaining or long-lasting business or stock market cycle. More importantly, I said to Guy that we seem likely to be passing on the first generation of lower living standards because all forecasts come prepackaged with lower growth rates and higher tax rates.
During the show, Karen Finerman waxed enthusiastically about the ISM report. I didn't have a chance to respond, but here is what I would have said in response to her optimism.
In the ISM report, orders were down for the second straight month, backlog was flat, and inventory was up 10% sequentially (month over month). Moreover, there was a meaningful downward revision in construction spending in the prior month. As Bill King wrote this morning in
The King Report
, "Industry is building inventory, but transportation data show that the goods are not yet moving in concert."
And here are some of the more ominous quotes contained in the ISM release:
- "Still a very difficult environment -- commodity increases threaten recovery and don't seem to correlate with any supply/demand fundamentals." (Food, Beverage and Tobacco Products)
- "The improvement seen earlier is not holding." (Primary Metals)
- "After several rather busy months, we are seeing the order intake for early next year soften." (Transportation Equipment)
It remains my view that the markets will look right through the strong ISM, just the way investors looked through the strong GDP print late last week. In fact, the ISM reading of 55.7 might be the most expensive in history. (Heck, we could theoretically get ISM to 100 if we throw another $25 trillion to $50 trillion at it, which may in fact be the plan!)
Frankly, if the current strategy of massive fiscal stimulation was so easy, Zimbabwe would be a worldwide economic powerhouse.
We should not lose sight that the better-than-expected third-quarter 2009 GDP was created by the government's massive monetary excursion in which consumers were induced, through various government programs with far less than one time multipliers, into spending what precious little savings they had accumulated since the crisis began. Ten years of egregious use of debt does not resolve itself in 12 months, and in the interim, policymakers are encouraging more irresponsible behavior on top of it.
The next 12 months are going to be marked by more uncertainty than certainty -- and, to me, the last two important economic releases (GDP and ISM) strengthens the case that the foundation of economic growth is shaky relative to the consensus view of self-sustaining growth.
More on the Top 20 Signs of How Bad the Economy Is
Melissa ended the segment by highlighting what the "Fast Money" group thought were my best of the top 20 list in yesterday's opening missive.
Here they are:
- "The economy is so bad that a picture is now only worth 200 words."
- "The economy is so bad I saw the CEO of Wal-Mart (WMT) - Get Walmart Inc. Report shopping at Wal-Mart."
- "The economy is so bad that I bought a toaster oven and my free gift with the purchase was a bank.
It was a great show, and I can't wait to get back on!
Doug Kass writes daily for
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At the time of publication, Kass and/or his funds had no positions in stocks mentioned, although holdings can change at any time.
Doug Kass is the general partner Seabreeze Partners Long/Short LP and Seabreeze Partners Long/Short Offshore LP. Under no circumstances does this information represent a recommendation to buy, sell or hold any security.