NEW YORK (
) -- Doug Kass of Seabreeze Partners is known for his accurate stock market calls and keen insights into the economy, which he shares with
readers in "The Edge," his daily trading diary.
This week, he reviewed his stance on the economy and the stock market and revealed the long and short trades that he's pressing right now.
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Where I Stand
Originally published on Dec. 17 at 8:25 a.m. EST.
"Before I speak, I have something important to say." -- Groucho Marx
Throughout the course of this year, "The Edge" has stressed that the economic outlook was uncertain, as I saw the market through a half-empty glass.
I viewed the tension between the near-term cyclical tailwinds of monetary easing (and the resumption of growth that they would bring) and the intermediate-term secular headwinds (and their impact on limiting growth) as likely providing an investment stalemate at best. Moreover, I suggested that the government's stimulus initiatives were poorly structured and would not, in the fullness of time, catapult economies toward a sustainable growth trajectory. Indeed, I believed (and still believe) that the policy of ever easy money (QE2) doesn't go to the core of our problems and will likely result in disappointing and uneven economic growth and in a generally unattractive investment backdrop.
"I have had a perfectly wonderful evening, but this wasn't it." -- Groucho Marx
For the first half of the year, I appeared to be on the right track. But I learned the lesson of that great country and western song title, "You Can't Roller Skate in a Buffalo Herd," as during the summer the
announcement of a new round of quantitative easing raised investors' animal spirits and the U.S. stock market launched a surprisingly strong rally.
"Life's real failure is when you do not realize how close you were to success when you gave up." -- Anonymous
While recent signs of economic growth have shown unambiguous improvement, I continue to believe that it is premature to extrapolate these signs of growth into a forecast for a smooth and self-sustaining recovery. The withdrawal and adverse consequences of easy money loom ever closer as do the numerous nontraditional headwinds (fiscal imbalances at the local, state and federal levels; structural unemployment; the impact of lower home prices and so on).
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Near term, equities are overloved and overbought.
Over the past two weeks, our country's leadership has taken the easy route and has demonstrated that there will be no meaningful movement in cutting our burgeoning deficit -- once again, trading off near-term growth at the cost of intermediate-term pain. The bond vigilantes smell blood, recognize this inertia and are now exacting a price to be paid in much higher interest rates. (The rapidity of the recent rate rise is but one of the accumulating factors that will likely weigh on stocks in the weeks/months ahead.)
Higher interest rates are already taking a toll on the still-depressed housing market. Applications for new homes and refinancings are again heading lower (over the last three to five weeks), as the rate on the 30-year fixed mortgage has abruptly climbed back to seven-month highs. This rate rise comes at a bad time as mortgage-gate has delayed the foreclosure/sale process until early 2011, which will likely result in an outsized and steady supply of inventory for sale in the months ahead.
Rising mortgage rates and an avalanche of supply are a toxic cocktail for housing.
Meanwhile (consistent with rising stock prices), the bullish talking heads' chorus of smooth and self-sustaining economic growth has grown ever louder, ignoring the warning signs of worsening payrolls growth, the temporary nature of the stimulus, a continued buildup in household savings, a banking system that is still in a healing mode, the potential for "beggar thy neighbor" policy decisions, Chinese inflation out of control, the sinking ships (of Japan, Ireland, Greece and Spain), the specter of corporate profit margin erosion (evolving from higher input costs), rising tensions between Iran and Israel, and a worsening housing market.
Given that the market does not appear to be factoring in my many concerns and seems to be expecting a smooth recovery without fumbles, I continue to see an unfavorable risk/reward ratio.
"How prone to doubt, how cautious are the wise!" -- Alexander Pope
That said, with the benefit of hindsight, I was too cautious this year. Nevertheless, the individual stocks discussed on "The Edge" (both longs and shorts) have done reasonably well, and, though being intermittently short the indices, my strict risk-control techniques limited my loss exposure.
In looking back at my columns this year, I emphasized too many shorts and too few longs.
I will try to do better on "The Edge" in 2011.
To summarize, as 2010 concludes, I continue to maintain the notion that, in light of the many unresolved macroeconomic issues, selectivity, discipline and caution should still be an investor's mantra. (As a matter of strategy, my preference is always to err on the side of conservatism, ever aware that I would rather lose opportunity than capital, especially in uncertain times.)
In the uneven economic environment I envision, stockpicking and a flexible and bolder opportunistic trading approach (based on shorter-term catalysts) seem to be the likely ingredients to superior returns, and this is the course and strategy I plan to embrace on these pages in 2011.
"You have to know the past to understand the present." -- Dr. Carl Sagan
One final thought.
Throughout my investment career, I have learned that most like the dreams of the future better than the history of the past.
We should all be mindful, however, that, with few exceptions, many (if not most) observers -- and that includes Ben Bernanke -- missed the 2008-2009 downturn, despite the clear and accumulating evidence of economic uncertainty and growing credit risks (and abuses). The analysis of multidecade charts and economic series convinced most (along with other conclusions) that home prices were incapable of ever dropping, that derivatives and no-/low-document mortgage loans were safe, that there was no level of leverage (institutional and individual) too high and that rating agencies were responsible in their analysis. Importantly, they also failed to see the signposts of an imminent deterioration in business and consumer confidence that was to result in the Great Decession and credit crisis of the last decade. Many of those who are now expressing more extreme levels of optimism were in the above camp and experienced significant pain in the last investment cycle, while "The Edge" profited in those years.
Indeed, as I recently wrote, many investors seem to be similar to victims of Plato's allegory of the cave, a parable about the difficulty of people who exist in a world shaped by false perceptions to contemplate truths that contradict their beliefs. This is why so many investors were blindsided by the last downturn and, from my perch, continue to wear rose-colored glasses.
In the famous simile of the cave, Plato compares men to prisoners in a cave who are bound and can look in only one direction. They have a fire behind them and see on a wall the shadows of themselves and of objects behind them. Since they see nothing but the shadows, they regard those shadows as real and are not aware of the objects. Finally one of the prisoners escapes and comes from the cave into the light of the sun. For the first time, he sees real things and realizes that he had been deceived hitherto by the shadows. For the first time, he knows the truth and thinks only with sorrow of his long life in the darkness.-- Werner Heisenberg, Physics and Philosophy
Today, as several years ago, most investors clearly don't share my concerns, and for now, as the country and western song lyric goes, "I feel like a bug on the windshield of life."
I suspect that the punishment those investors experienced in 2008-2009 was too brief or perhaps it was reversed too soon. (Of course, there is always the chance that such behavior won't be punished again the second time around!)
Nevertheless, with stocks so elevated, I believe the prudent course shouldn't be the adoption of too much risk at the current time.
"Life is divided into the horrible and the miserable.... It is full of misery, loneliness and suffering, and it's over much too soon" -- Woody Allen
It is important to emphasize that "The Edge" does not always reside in a bear cave -- I would be counseling substantial short positions today if I was Nouriel-like, and I would be sounding the Cassandra-like warning that the market and the economy were as vulnerable as they were three years ago. This is certainly not the case, and I don't want subscribers to think that another economic apocalypse and/or stock market crash is imminent.
I do want subscribers to understand, however, that, to some degree, today's optimistic investor expectations might be misguided and that the market's risk/reward remains unfavorable to me.
What seems easy for bullish investors to imagine today might prove more difficult in reality next year, as prospect is often better than possession.
"Life is not a spectacle or a feast; it is a predicament." -- George Santayana
In all likelihood, the U.S. economy will muddle through, though that may not be the case in Europe. It remains my view that the anticipated anemic slope of domestic economic growth in 2011-2012 exposes the improving economic cycle to policy or exogenous surprises and influences.
Every cycle poses new challenges to growth, and the current cycle is (very) different this time. As I have frequently chronicled, so many nontraditional headwinds represent challenges to the U.S. economy and stock market. Most important, the weight of the structural disequilibrium in the U.S. jobs market coupled with a still-struggling housing market mired by an unprecedented shadow inventory of unsold homes are some of the more conspicuous and unfortunate byproducts of the credit crisis of 2008-2009 and represent important impediments to a self-sustaining domestic economic recovery that the crowd appears to see with increasing clarity.
Arguably, over the past few months, investors' "heads we win, tails we win" response to news is becoming increasingly reminiscent of the period approaching prior market peaks, providing to me (again) a clear reminder of the wisdom of Santayana, who once observed that "those who cannot remember the past are condemned to repeat it."
Stay tuned for 2011, as it promises to be as exciting as its predecessor.
For now, as another famous country and western line (that I love) goes, "Get your tongue outta my mouth 'cause I'm kissing you goodbye."
Originally published on Dec. 17 at 10:31 a.m. EST.
I am pressing my longs in
And I'm pressing shorts in
PowerShares QQQ Trust
At the time of publication, Kass was long Yahoo!, Cisco and Huntington Bancshares and short Fastenal, PowerShares QQQ Trust and Pitney Bowes.
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.