This blog post originally appeared on RealMoney Silver on Nov. 27 at 7:12 a.m. EST.
"The power to become habituated to his surroundings is a marked characteristic of mankind."
-- John Maynard Keynes
As we learned when equities moved to unimaginable levels nine months ago, the stock market, like economics, can be a dangerous and sometimes inestimable science.
Many strategists and talking heads in the business media, like Keynes' economists, are often useless, especially during "tempestuous seasons," as they seem to only tell us that when the storm is past the ocean is flat again. The same applies to their recognition of emerging downturns during periods in which we seem to be experiencing sunny skies.
"The market can stay irrational longer than you can stay solvent."
There exist numerous mysteries to the recent market advance. With modest corporate buyback activity, an expanding and abundant supply of secondary offerings, an overseas investor disincented to buy U.S. stocks owing to a falling greenback, outflows in domestic equity mutual funds and a generally inactive hedge fund industry trying to preserve 2009's gains, it is hard to understand what is propelling the recent market rise (in scope and in persistency). The most obvious answer is that large domestic pension plans and endowments have moved to reallocate funds from fixed income to equities after allowing the ratio of bonds to stocks to rise dramatically by the time the U.S. stock market hit bottom in March 2009. (Recall, the underweighting of stocks to bonds in March and the expectation of a large reallocation back into equities was one of the cornerstones to my market bottom call back then).
Not the least of the latest mysteries is the markets' inexplicable optimism surrounding policy that has contributed to rising gold prices and a plunging U.S. dollar.
"The best way to destroy the capitalist system is to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens."
Read history. Financial history shows that if you owe your bank a hundred dollars, you have a problem. But if you owe your bank a million dollars, the bank has problems.
The same can be said for our country.
Contrary to growing belief, an unhealthy U.S. dollar -- though embraced by some in the trading community who couldn't define purchasing parity power (PPP) and by some who couldn't tell the difference between a Norwegian krone and a Nigerian naira -- is not stock-market-friendly.
A plunging currency does not sow the seeds of a sustainable market and economic advance -- for if our country owes central banks trillions of dollars, everyone has a problem.
"When the facts change, I change my mind. What do you do, sir?"
Nearly a trillion dollars of stimulation and a near-zero interest-rate policy were required to print a revised 2.8% GDP for the third quarter of this year. Given a cooked consumer,
and an elevated unemployment rate, it requires a leap of faith that we are entering a prolonged period of a smooth, consistent and positive economic growth in the face of the withdrawal of monetary and fiscal stimulation in 2010. Already more-tentative signs of economic growth have appeared. Couple this with a resurgence in bullish sentiment and the emergence of weakening technical signals (e.g., more negative breadth, tepid volume, poor relative strength of financials and changing market leadership away from small-caps to large-caps), and this could prove to be a toxic combination serving as ingredients for an imminent market fall.
Amid today's optimism, the aforementioned shadows lurk, as does the upcoming impact of those
which are the aftermath of the credit crisis. Though ignored by many, the length of those shadows are now expanding -- they are more ominous with every uptick as Mr. Market's risk/reward relationship worsens.
"Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as a result of animal spirits -- of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities. ... If the animal spirits are dimmed and the spontaneous optimism falters ... enterprise will fade and die."
No doubt Yale's Bob Shiller's "
" have greased our capital markets since the summer and may have even exaggerated the magnitude of the market's ramp.
I met a traveller from an antique land
Who said: "Two vast and trunkless legs of stone
Stand in the desert. Near them on the sand,
Half sunk, a shattered visage lies, whose frown
And wrinkled lip and sneer of cold command
Tell that its sculptor well those passions read
Which yet survive, stamped on these lifeless things,
The hand that mocked them and the heart that fed.
And on the pedestal these words appear:
'My name is Ozymandias, King of Kings:
Look on my works, ye mighty, and despair!'
Nothing beside remains. Round the decay
Of that colossal wreck, boundless and bare,
The lone and level sands stretch far away.
-- Percy Shelley, Ozymandias
This morning we walk into substantially lower stock markets around the world as Dubai's Ozymandias is revealed. The central theme of Shelley's sonnet is the inevitable decline of all men, and of the empires they build, however mighty in their own time. It is said that history doesn't repeat itself, but it surely rhymes. Isn't Dubai World just one gigantic egotistical monument in the desert?
I would expect that in the fullness of time, this colossal monument to a sultan's ego will go the way of Ozymandias' Egyptian "works" and be swallowed by the desert. Between the egotistical projects, racehorses and such, the great Middle Eastern oil fortunes will find a way of becoming much smaller fortunes. On the other hand, the fortunes invested in biotech and medical research, while not producing monuments, will continue to pay off for many years in the future. Compare the results from the investment in Dubai World with Israel's funding of the Weizmann Institute and you'll get my drift.
Could Dubai reverse the animal spirits (with the carried trade) and ultimately lead to a much-larger-than-expected market drop? Of course it can. As I have recently suggested, markets are being priced closer to perfection and as a result, this makes the world's capital markets vulnerable to an exogenous and negative event like the Dubai credit situation. There could be a vacuum of bids underneath the world's markets as investors could say Doobye to the breathtaking advances since March.
Sentiment surveys (e.g., Investors Intelligence) guide us to the conclusion that many have already succumbed to the market's tempting advance. But, remember, once doubt begins it often spreads rapidly.
Successful investing is anticipating the anticipations of others, and despite the renewed and more plentiful calls for S&P 1200 by year-end, it might be time to anticipate a reversal of fortune -- an unpopular, unimaginable and unexpected outsized market decline.
All that said...
"The long run is a misleading guide to current affairs. In the long run we are all dead."
At the time of publication, Kass and/or his funds were long/short XXX, 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.