This blog post originally appeared on RealMoney Silver on June 17 at 8:56 a.m. EDT.Since late-April/early-May, the S&P 500 has dropped by nearly 100 points. During that interim interval, I have turned from being very pessimistic (when many investors were greedy) to now slightly more optimistic (when many are fearful) in my investment views. Such should be the case, unless one sees the onslaught of a bear market -- something I do not anticipate. Speaking of anticipation, unlike many on RealMoney, I am anticipatory, not reactionary, to prices. It doesn't make me (or them!) better or worse for this approach, but it is my style as a longer-term investor. And, it means, by definition, that I am early to trend changes. It paid off, in spades in 2007-2009, and I am hopeful the same will occur this year. For a perspective, I want to review a chronology of my economic and stock market views since the middle of April 2011. In mid-April, I warned of the " Apocalypse Soon" and cited several possible headwinds to a smooth and self-sustaining trajectory of growth:
In the week that followed, I expressed the view that the market's outlook had deteriorated further and that it was time to be more defensive:
- Oil Vey. Higher energy costs remain the biggest risk to profit and worldwide economic growth -- it is the greatest and most pernicious tax of all. As I have documented in The Edge (my exclusive RealMoney Silver trading diary), the rapid rate of change in the price of crude oil has historically presaged weakness in U.S. stock prices.
Brent Crude -- 26-Week ROC
A world rolling quickly toward industrialization, with an emerging middle class and goosed by an unprecedented amount of quantitative-easing has conspired to pressure commodity prices (especially of an energy kind). Moreover, Japan's nuclear crisis has likely further increased our dependency on fossil fuels. U.S. policy is on a slippery slope on which oil might be increasingly impacted by the outside influences of Mother Nature and political developments -- all beyond our control.
S&P 500 -- 26-Week ROC
- Higher Input Prices. Besides energy prices, a broadening rise in input prices also threaten corporate profit margins. While Bernanke is unconcerned with rising inflationary pressures and the CRB Index, as the Economic Cycle Research Institute notes, the Fed runs the risk, once again, of being behind the inflation curve and, in the fullness of time, being faced with the need to introduce policies that could snuff out growth with errant policy. Hershey (HSY), Procter & Gamble (PG), Colgate-Palmolive (CL), McDonald's (MCD), Wal-Mart (WMT) and Kimberly-Clark (KMB) have all announced sharp price increases (of 5% to 10%) in the cost of their staple products, running from chocolate kisses to diapers!
- A Debased U.S. Currency. The cost of 2008-2011 policy is a mushrooming and outsized deficit. Since the generational low in March 2009, the U.S. dollar has dropped by over 23% against the euro, as market participants have dismissed the notion that the hard decisions to reduce the deficit will be implemented. As Nicholas Kristof wrote in The New York Times yesterday, "This isn't the government we are watching, it's junior high school.... We're governed by self-absorbed, reckless children.... The budget war reflects inanity, incompetence and cowardice that are sadly inexplicable." At the opposite side of our plunging currency is the message of ever-higher gold prices. (Warning: Dismissing the meaning of $1,500-per-ounce gold might be hazardous to your financial and investment well-being.)
- The Rich Get Richer, the Poor Go to Prison but Everyone Else Is Victimized by Screwflation. Most importantly, policies have placed continued pressures on the middle class, with the cost of necessities ever-rising and wage growth nearly nonexistent. The savers' class has suffered painfully from zero-interest-rate policy and quantitative-easing, policies that have contributed to the inflation in financial assets (and to an across the board hike, or consumer tax, in commodity prices) but have failed to trickle down (until recently) to better jobs growth, to an improving housing picture or to an opportunity for reduced consumer borrowing costs and credit availability. Meanwhile, the schism between the haves (large corporations) and the have-nots (the average Joe) has widened, as best reflected in near-record S&P 500 profits and a 57-year high in margins. Corporations have feasted (and rolled over their debt) in the currently artificial interest rate setting, but the consumer and small businessman has not fared as well. Particularly disappointing has been overall jobs growth (as reflected in the labor participation rate) and the absence of wage growth (as the average workweek and average hourly earnings continue to disappoint). It is my view that ultimately corporations' margins will be victimized by the screwflation of the middle class, as rising costs may produce demand-destruction and an inability for companies to pass on their higher business costs.
- Structural Unemployment Is Ever-Present. Globalization, technological advances and the use of temporary workers becoming a permanent condition of the workplace are all conspiring to keep unemployment elevated and wage growth restrained. The lower the skill grade and income, the worse the outlook for job opportunities and real income growth. (This is not a statement of class warfare; it's a statement of fact.)
- Home Prices Remain Pressured. Meanwhile, the consumer's most important asset, his home, continues to deflate in value, despite the massively stimulus policies, a multi-decade high in affordability, improving economics of home ownership vs. renting and burgeoning pent-up demand (reflecting normal population and household formation growth). Consumer confidence has continued to suffer from the unprecedented home price drop, which has been exacerbated by the aforementioned (and decade-plus) stagnation in real incomes. The toxic cocktail of weak home prices, limited wage growth and nagging upside commodity price pressures (particularly from the price of gasoline), will likely pressure retail spending for the remainder of 2011.
At the end of April, I offered that investors had a " False Sense of Security" and were too confident that the remarkable share price momentum held promise for smooth and self-sustaining economic growth. At best, I opined, the signposts were for subpar economic growth, at worse, a double dip was not out of the question. During the first week of May, I suggested to "yell and roar, but sell some more." A week later I listed the key factors that were guiding me toward expecting a near-term slowdown in the rate of domestic economic growth and limited upside to the U.S. stock market..
Finally, even though the buy-on-the-dip mentality is very much in place, Mr. Market's technical condition has eroded further. Buyers are not as aggressive as in November 2010's correction, which presaged another up leg - for instance, unlike November 2010, there has not been a 90%-plus up day. Moreover, of late, short-term oversolds have gotten deeper.
- Consumer nondurable issues have outperformed, a classical sign of a more defensive market.
- Former market-leading stocks -- namely, Google (GOOG) and Apple (AAPL) -- have begun to underperform.
- First-quarter earnings reports have been disappointing and, when combined with No. 4 below, render the $95-a-share consensus S&P forecasts for the year more problematic.
- The price of energy products and other input prices show little signs of moderating.
In mid-May, I raised the notion that, in a more uncertain and volatile setting, the best bet was in opportunistic trading, not in buying and holding. A week later, I suggested that my negativity was reinforced by the slew of poor economic data. At that time, I saw nothing emanating from the market's action that changed my conclusion that the upside reward was limited and that the threat of downside risk remained increasingly likely (if not probable).
- A low in bond yields: The continued drop in the yield on the 10-year U.S. note to 3.15%.
- A double dip in housing: A still-large shadow inventory of badly delinquent and foreclosed homes continue to weigh on home prices, which resumed their fall in first quarter 2011.
- Worrisome group rotation: The continued improvement (absolutely and relatively) of the consumer nondurable sector.
- Weakening commodities: We have witnessed a decline in the price of copper (to below its 200-day moving average), oil and other major industrial commodities.
- Economic indicators flash caution: A multiyear low in the Baltic Dry Index, a weak household jobs survey, the ISM nonmanufacturing Index falls to the lowest level in nine months and, for the fourth straight week, we get an initial jobless claim print above 400,000.
- Emerging weakness in non-U.S. markets: A break is developing in the natural-resource-based regional markets of Australia, Mexico, Canada and Brazil.
Near the end of May, as economic releases grew ever more ambiguous, I highlighted my continuing view that:
I continue to see, as I have for months, an inconsistent and uneven economic recovery -- difficult for corporate managers and investment managers to navigate. Tail risk, greater earnings volatility and corporate margin and profit challenges are the headwinds I see above and beyond the nontraditional issues of fiscal imbalances, higher marginal tax rates and elevated structural unemployment caused by globalization, technological advances and temporary employment as a permanent fixture to the jobs market. And I see a U.S. consumer, who has been victimized by screwflation, as particularly vulnerable and exposed. Money freed up from nonpayment of mortgages and recession fatigue have likely temporarily buoyed retail sales, but that slope is slippery and provides the sustainability of growth with a weak foundation. As a consequence I envision, unlike most, some pressure on P/E multiples this year: I still expect a flat year for the S&P 500.I started my commentary in June by telling my troubles to "Fast Money," emphasizing the continued need to be defensive. The next week, in " Four Questions to Ponder," I concluded that a spate of consistently weak economic data, rising sovereign debt contagion, a technical breakdown and other factors are supportive of my continued expectation that the U.S. stock market was likely to be range-bound between 1250 and 1350 on the S&P 500. And, then, with the S&P nearly 100 points lower than it was in April, I turned more optimistic in " It's the Economy, Stupid," when I wrote that the preconditions for a market bottom could be falling into place:
I hope this perspective is helpful to readers. 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.
- Corporate balance sheets and income statements continue to display strength. While I see some vulnerability to corporate profits, my estimates are only a few dollars per share below consensus.
- Valuations are not stretched, especially relative to inflation and interest rates. At 1250, the S&P 500 will be priced at a reasonable 13.5x my 2011 S&P forecast of $93 a share. (Price is what you pay; value is what you get.)
- Uneven and more volatile economic and profit growth are my baseline expectations. But an extended (yet lumpy) economic up-cycle still appears the most likely outcome. More effective and productive public policy could extend the recovery further.
- At 1250, the market will be sufficiently oversold technically, and sentiment will have moved to a more negative extreme. Always remember that a public opinion poll is no substitute for thought.
- Individual investors are relatively uninvolved and hedge funds are conservatively positioned.