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Kass: Permabulls Remain in Denial

Bulls won't recognize a recession until stocks are lower -- and by then it will be too late.
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This blog post originally appeared on RealMoney Silver on Dec. 14 at 8:46 a.m. EST.

Last night, I appeared on


"Kudlow & Company." Here is the


of my appearance.

As I


recently, talking with Larry about the stock market can sometimes be tough, because he is a permabull, a sincere believer in Goldilocks and a true believer that the U.S. economy/stock market is the "greatest story never told."

By contrast, I, as I have


on numerous occasions, I believe that the U.S. economy is "the greatest story ever



On the panel last night was Dynamic Mutual Funds' Noah "Boychick" Blackstein and Trend Macrolytics' Don Luskin.

Both Don Luskin and Larry Kudlow, two proponents of free-market capitalism, criticized the Fed for being too meek in cutting rates and for the manner in which it communicated the liquidity injection on Wednesday morning.

It is truly ironic to me that Don and Larry, two of the greatest devotees to the strength of the domestic economy, are among the most vociferous critics of the Fed. If all is well in the U.S. economy, why do they continue to suggest that monetary policy should be loosened dramatically, and that the Fed is not doing enough?

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By contrast, I suggested that the issue was much broader. From my perch, market participants have lost faith in both the Fed's recent actions and the Treasury Department's mortgage proposal as solutions to the deeply rooted credit problems, and this widespread vote of no confidence is producing inflation and currency fears.

These moves are no longer seen as a panacea. After all, as I remarked, Libor remains elevated, equities are weakening, and the TED spread is historically high. So there is, I insisted, a growing recognition that the credit crisis has deepened.

As I wrote yesterday:

The current credit crisis emanated from the unprecedented growth in debt over the last two decades, which was accompanied by the cessation of lending/borrowing judgment. Historically low interest rates (brought to us by the prior Fed chairman) encouraged the quest for yield, and normal due diligence was abandoned. The outgrowth is a world awash in an unwieldy and unregulated derivative market that managed to bypass traditional banking regulation. It is a setting which patchwork mortgage proposals and/or creative Fed initiatives will not likely remedy in short order.

Most importantly, it seems that the markets are beginning to accept the notion that the financial workout will take time and, in all likelihood, can only be relieved by the natural forces of an extended recession.

I went on to say that corporate profit, business spending and personal consumption forecasts are going to be revised down by consequential amounts.

Larry Kudlow and Don Luskin attacked my


that the economy is at the door of recession.

In support of my argument, I tried to explain the causalities I saw leading to that recession: the housing depression, the subprime contagion moving up the ladder of credit, and the delta of economic growth is clearly slowing, with third-quarter 2007 5% GDP growth morphing into 1.5% growth in fourth quarter 2007 and, as judged by

Morgan Stanley

(MS) - Get Free Report

, slightly negative readings in the first two quarters of next year. The other panelists considered Morgan Stanley a permabear on the economy -- a new one to me!

Unfortunately, I was repeatedly interrupted before I could list the growing evidence of a probable recession. Some of these items include

consumer confidence

plummeting, seized-up

credit markets

, weakening retail sales -- the November strength was bogus-adjusted for food and energy inflation -- and poor durable-goods reports.

Moreover, other leading indicators -- such as the Baltic Dry Index dropping by 10% from its high, housing permits and rising job claims -- all point to a rapidly eroding economy.

The panelists seemed keen on partial and conformational economic analysis and also chose to ignore the negative impact of Thursday's release of the PPI, which recorded its largest gain in nearly 35 years. (My


scenario seems to be playing out.) As well, they chose to ignore the forward-looking equity market and its current weakness, although Larry routinely cites market strength as support to his uplifting economic forecasts.

In the final analysis, what Don and Larry don't appreciate (perhaps because they don't manage money) is that by the time it is clear that the economy has weakened toward recession, stocks will be much lower. It will be too late.

At time of publication, Kass and/or his funds were short Morgan Stanley, although holdings can change at any time.

Doug Kass is founder and president of Seabreeze Partners Management, Inc., and the general partner and investment manager of Seabreeze Partners Short LP and Seabreeze Partners Short Offshore Fund, Ltd.