Kass: Clouds on the Horizon

This blog post originally appeared on RealMoney Silver on April 13 at 7:31 a.m. EDT.

As I have recently communicated, it is my view that stocks made an important low in early March, perhaps even a generational low, and may very well continue to advance. There is little question, however, that the road to higher ground will be full of potential potholes in light of the economic and stock market challenges from traditional headwinds such as the uncertain and depressed corporate profit cycle, the unprecedented number and magnitude of dividend cuts, the devastation in household wealth from lower home and stock prices, the specter of a glut of additional foreclosures that could short circuit a stabilization of the housing markets, the crippled capital base and reduced lending capacity of the world's banking institutions, and the still weakening and depressed jobs market.

As well, the presence of nonconventional headwinds pose risks, and since investors have a limited experience and historical perspective in dealing with them, it likely insures a more volatile market backdrop and places limitations to the market's upside potential. Some of those nontraditional headwinds include the following:

  • the broad geographic reach of the current recession;
  • the increased burden and cost of regulation;
  • the economic impact of the obliterated (but previously important) shadow banking system and the associated reduction in securitized lending market capacity;
  • the more important role of government in the private sector;
  • the possible impact of protectionism and trade barriers;
  • the degree to which individual and institutional investors have become risk-averse and have been "turned off" to equities; and
  • most important, the unusual causes of the current economic downturn and and uncertainty of business confidence that follows from the deleveraging of debt on bank and consumer balance sheets.

As I look beyond the current market rally I have five additional medium-term concerns:

    1. I am worried that, even though there are currently signs of economic stabilization, the slope of the recovery will be shallow by most historical standards and the possibility of an economic double-dip in late 2009/early 2010 must be considered, particularly in light of a heavily indebted consumer coupled with proposed tax rate increases by the new administration.

    2. The government's policy efforts to ring-fence the banks' toxic assets might not succeed, and the transmission of credit could remain clogged for some time to come. In this instance, not only will economic activity disappoint but still-high yields in the corporate bond market could provide stiff competition to equities.

    3. I remain concerned that investors could grow too optimistic, too fast, in a continued extension of the current market rally. Already, many talking heads in the media who were scared witless a month ago have become born-again permabulls in recent days.

    4. The magnitude of the required policy actions to stabilize the credit market and domestic economy is materially increasing the size of the U.S. deficit and raises our reliance on the kindness of strangers in funding our mounting debt burden. That's a slippery slope in which much can go wrong.

    5. The world remains a political powder keg. Continuing my 1938-1939/2008-2009 parallel, I am concerned that Pakistan is the 1939 geopolitical risk-equivalent of Germany.

Regardless of the near-term strength, undoubtedly investors will face a volatile backdrop over the balance of the year in which both corporate managers and investment managers will have a difficult time navigating a lumpy and inconsistent economic growth trajectory.

Hopefully, the gray skies expressed above are only clouds passing over the head of Mr. Market.

As seen in the follow chart, I continue to maintain that the S&P 500 could rise considerably further (to about 1,050) by mid to late summer, but the road to higher ground will likely be bumpy.

SPDR Trust (SPY) --Expectations
Bloomberg

Volatility, prudence and common sense dictates, especially in light of the sharp rise in equities over the past five weeks, above-average cash positions, smaller-than-usual investment/trading positions and an opportunistic investment strategy that complements a buy/hold strategy with a trading view.

Beyond a summer peak in equities, the market's outlook appears more problematic, and my longer-term expectation of an uneven and inconsistent economic landscape over the next few years remains intact -- an ideal setting for a two-sided market, with opportunities to profit with both long and short positions.

Doug Kass writes daily for RealMoney Silver , a premium bundle service from TheStreet.com. For a free trial to RealMoney Silver and exclusive access to Mr. Kass's daily trading diary, please click here.


Know What You Own: The most active stocks in Monday's midday trading included Citigroup (C), Bank of America (BAC), Direxion Financial Bulls 3X Shares (FAS), Financial Select Sector SPDR (SPY), General Electric (GE), Wells Fargo (WFC) and American International Group (AIG). For more on the value of knowing what you own, visit TheStreet.com's Investing A-to-Z section.

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 Long/Short LP.

More from Emerging Markets

Wall Street Looks To Extends Gains After Goldman Earnings Beat, China Data

Wall Street Looks To Extends Gains After Goldman Earnings Beat, China Data

China's President Xi Jinping Tells Boao Forum He Supports Opening Markets

China's President Xi Jinping Tells Boao Forum He Supports Opening Markets

U.S. Stock Futures Steady; Asia Stocks Mostly Lower

U.S. Stock Futures Steady; Asia Stocks Mostly Lower

Jim Cramer: There Are Plenty of Shorts in Constellation Brands

Jim Cramer: There Are Plenty of Shorts in Constellation Brands

Renault Shares Hit 10-Year High on Nissan Merger Report

Renault Shares Hit 10-Year High on Nissan Merger Report