This blog post originally appeared on RealMoney Silver on Nov. 29 at 7:59 a.m. EST.
Last night, I appeared on
"Kudlow & Company."
of my appearance.
Talking with Larry about the stock market can sometimes be tough because he is a permabull, a genuine believer in Goldilocks and a true believer that the U.S. economy/stock market "is the greatest story never told." And the fact that before the show he had just left from a meeting with President Bush coupled with Wednesday's historic stock market advance made him even more optimistic.
Making things even worse is that the audio system at the studio was messed up, and I had some very loud feedback in my ear that made it difficult to speak. Was this a plunge-protection-team plot to drown out a voice of reason? Hadn't they done enough to us bears during the day?
At least I had my friend/buddy/pal,
John Browne, on the show with me to defend reality in the show's first segment.
Larry and fellow bull Jim Lacamp, portfolio manager at RBC Dain Rauscher, were full of contradictions last night. For example, the bulls argue that the possibility of lower interest rates, as interpreted from
Vice Chairman Donald Kohn's dovish remarks yesterday, is seen as an overwhelmingly positive for equities, although the reasons behind the need for the rate cut are dismissed. From my perch, the Fed is scared witless about what lurks in the credit system.
By contrast, Dallas Fed President Fisher contradicted Kohn later in the afternoon, but the markets (and the Kudlow bulls) ignored his statement "that the Fed would not be bullied by the markets and would do what is right." Also dismissed is that the first two cuts in August and September not only failed to revive economic growth but, more importantly, the credit markets materially deteriorated in the interim.
Larry and Jim also cited a sharp drop in oil prices over the last week as a catalyst to the market's advance. Will Larry note tonight the reversal of nearly $4 per barrel in the price of oil this morning after the large oil refinery explosion overnight? Will the equity markets turn back down with the spike in crude? Stay tuned.
Jim Lacamp, similar to Larry, dismissed worrisome economic/credit news and cited the drop in bond prices and the climb in yields as proof positive that all was well. By contrast, I argued that while the yield on the 10-year U.S. note climbed dramatically over the last two days, it was a reversal that followed the largest drop in 20 years in the 10-year note yield on Monday, to about 3.88%, and it followed a broad-based drop in yield from about 4.80% over the last few months.
I argued that, if anything, there remains a clear message from the fixed-income markets -- namely, that there is a flight to quality (reflecting credit fears) as well as growing concerns of future domestic economic growth in early 2008.
Also mentioned by the bulls last night were the positive ramifications of the Abu Dhabi investment in
. Not discussed were the
of that reverse convertible investment.
Less than two months ago, Citigroup issued $3 billion of 5.30% bonds, and 10 days ago it issued another $475 million of bonds with a 5.40% coupon -- both without a call option. Even adjusting for the mandated conversion of the $7.5 billion placement with Abu Dhabi, the cost of the financing was at least 325 basis points above Treasuries.
The King Report
compares the Citigroup financing of 325 basis points with a bond issue by
, which recently sold bonds at 158 basis points over Treasuries, and
, ditto at 165 basis points over. King also raises the thoughtful question of why Citigroup had to go to Abu Dhabi instead of funding the deal domestically.
As I mentioned on the program last night, we mortals (as contrasted with those in the press box) have to deal with the vagaries of the economy and of the markets every day; we cannot afford the dogma associated with permabulls or permabears. As I
yesterday, whether from the bullish or bearish perch, a degree of market-gaming is necessary (especially in a low-return environment) to deliver good investment returns.
When conditions come together positively, as they did recently, the market mostly rallies. But when optimism rises, sentiment must be gauged against the fundamental backdrop. This is why I believe that there is a limit to the market's year-end advance. And this is why Tuesday's and Wednesday's rally is probably nothing more than a dead-cat bounce within the context of a fundamental and negative change in the credit markets, which will evolve for years, and a disappointing backdrop for corporate profitability.
So, while the sentiment measures all point up for the markets, the fundamental setting (and the reason why Kohn delivered his worrisome message yesterday) remains in place and, importantly, will remain negative for some time to come:
- Consumer confidence is plummeting.
- The credit markets have seized up further, as Libor (the London inter-bank offered rate) has climbed for 11 consecutive days while the Libor spreads continue to expand.
- The consumer is languid -- check out the Sears Holdings (SHLD) release this morning.
- A nascent drop in business spending is upon us, as Wednesday's durable-goods report reflected one of the largest drops in non-defense ex-transportation orders since the series was established, and, within the report, computer electronic and products orders dropped by 8.4% and 15.2%, respectively, while communications orders declined by almost 25%.
- Most leading indicators -- such as the Baltic Dry Index (down 10 days in a row for a cumulative drop of nearly 10%), the durables goods report and job claims -- point to a quickly eroding economy.
At best, a domestic growth recession can be expected; at worst (and now the most likely outcome), a full-scale recession is in the cards.
A Fed cut will not be the panacea for the fundamental weakness that I see. In time, it will be seen as pushing on a string. Indeed, as I have noted consistently for months, the knock-on effects and unintended consequences of a Fed cut (rising inflation and a weaker U.S. dollar) could work against a rosy outcome.
Above all and over the intermediate term, the market discounts future cash flows, and those cash flows will likely disappoint in the period from 2008 to 2010.
While the tape looks great for now, it should be viewed within the broader context of technical erosion (new highs, breadth, etc.), and yesterday's continued advance put only a small dent in the weakening intermediate-term technicals.
Playing a year-end rally should be reserved for only the most facile investors/traders. And it should be viewed within the framework of a market that has no memory from day to day. It can reverse at any time.
Enjoy the dead-cat bounce. It probably won't last for long.
At the time of publication, Kass and/or his funds had no positions in the stocks mentioned, 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.