Kass: America's Pastime Applies to Markets

NEW YORK ( Real Money) --

Take me out to the ball game,
Take me out with the crowd.
Buy me some peanuts and cracker jack,
I don't care if I never get back,
Let me root, root, root for the home team,
If they don't win it's a shame.
For it's one, two, three strikes, you're out,
At the old ball game.

-- Jack Norworth, " Take Me Out to the Ball Game"

I have learned over my career that history is instructive -- it rarely repeats itself, but it often rhymes.

That said, we must all recognize that the past is not immutable.

Back in the summer of 2007 -- just before all hell was about to break loose -- I penned a column entitled "Take Me Out to the Ball Game for a Sense of History."

Because this week marks the beginning of Major League Baseball's spring training, I wanted to repeat the essence of that column from nearly five years ago, which has some bearing on today's markets.

As a cousin to Sandy Koufax, I grew up immersed in the game of baseball. I watched numerous games with my grandfather, Harry Koufax (Grandma Koufax's husband!) at his home in Mount Vernon, N.Y. I used to watch the peaceful look in Grandpa Koufax's eyes when he sat watching the games in his big cushy chair, cigar in mouth. I have never forgotten that look: He was in baseball heaven. I think I have that same look today when I watch ballgames. It's a look of contentment.

It wasn't only the Koufax connection that drew me to baseball; it was the purity of the game. Baseball is an untimed contest. The home run records, perfect games, the tar on the bats, the spit in the mitts all combined to create an almost genteel tradition among today's sports.

And that song. Take Me Out to the Ball Game is played during the seventh-inning stretch of every Major League Baseball game, with Harry Caray getting the credit for singing it first at a ball game in 1971. Call me sentimental or old-fashioned, but to this day, every time I am at a baseball game and I hear Take Me Out to the Ball Game, I well up in tears.

When I think of the game of baseball, the first thing that comes to my mind is a sense of historical perspective -- a respect for Roger Maris' (non-steroid-aided) record 61 home runs in one season (1961), Hank Aaron's 755 career home runs, Pete Rose's 4,256 hits, Joe DiMaggio's 56 consecutive games with a hit and Nolan Ryan's six no-hitters and 5,714 strikeouts.

Back in 2007, I got teary eyed at the tribute to Willie Mays, the "Say Hey Kid," at that year's All-Star Game. Perhaps it was that respect for baseball's traditions. Or perhaps it was a sense of a historical perspective, like when Sandy Koufax refused to pitch Game 1 of the 1965 World Series because the game fell on Yom Kippur, the Jewish Day of Atonement.

Where have you gone, Joe DiMaggio?
A nation turns its lonely eyes to you.

--Simon and Garfunkel, "Mrs. Robinson"

It is the same perspective and respect and sense of history that seems to be missing in the analysis of today's stock market by many of its participants -- most of whom, in the mounting competitive landscape (and given the outsized remuneration in the management) of hedge funds, invest/trade at the altar of momentum.

Yer blind, ump,
Yer blind, ump,
You must be out of yer mind, ump.

-- Damn Yankees, "Six Months Out of Every Year"

To some degree, fear and doubt have been driven from Wall Street today.

Certainly in 2007, the line between domestic economic progress and reality became almost completely blurred. But, as was the case four and a half years ago, there is no negativity bubble today but rather a bubble in complacency and in economic and stock market extrapolation.

One would have thought that lessons would have been learned by the unthinking speculation of daytraders in the U.S. equity market in the late 1990s, which resulted in a 70%-plus schmeissing of the Nasdaq or in the horrendous stock market during the two-year period following my original column in 2007. But nothing has been learned. The same mistakes are being made over and over. Other errata -- such as marking to market (collateralized debt obligations), trusting credit agencies (remember Enron, Tyco, etc.?), the use of margin debt (in 2007 at record levels) or even the buying of the crap that Wall Street packaged (again, collateralized debt obligations) -- will be buried and lost to history, and I guarantee that these mistakes will be repeated in the future.

The availability and price of credit in 2005-07 facilitated the housing bubble, which in turn followed the technology and Internet bubble of 13 years ago. It was a bubble that fed the private-equity boom and that, for a period of time, created a put under the market, which served to reduce fear and produced the aforementioned bubble in optimism (and the concomitant use of leverage, such as the carry trade, by hedge funds and the aggressive use of debt worldwide).

I began writing and warning about the tip of the iceberg of credit on this site -- namely, subprime lending -- back in 2006, when the ABX BBB was trading at par; it ultimately fell close to zero. Back then, as the deterioration in subprime began to spread, talking heads in the media grew bored of the subject and swept it under the lending rug, dismissing its possible impact on our markets and the domestic economy.

For a while, credit spreads were contained and locked in a narrow range -- surprising, considering how levered segments of our economy were, particularly at the consumer level -- but the spreads eventually bottomed and, in the fullness of time, widened to levels never thought possible. In turn, the housing market experienced its roughest patch in history -- home prices have dropped 35% since -- and the residential market's credit contagion grew and was not contained to subprime; it infected all the debt markets. In time, the drop in housing activity accelerated -- it has only now begun to stabilize in 2012 -- and there was a pernicious impact on operating results on the entire spectrum of America's companies (especially of a banking kind).

And the Great Recession of 2008-09 came to pass.

In time, the loose lending of 2000-06 moved well beyond the subprime mess and into motorcycle, automobile and credit card securitizations by 2007. And, as I predicted, it spread further to every town in the U.S. (and many abroad) populated by merchants ("Furniture World," "Textile World," "Cell Phone World," etc.) that had encouraged the consumption binge (buy now and pay later!).

The crack in the foundation of credit began to gain speed as the lending community grew more circumspect, and, in time, credit grew ever sparser.

The credit crisis was born, and the Great Recession moved speedily toward its height.

For a while in 2007-08, with the pressure on, the quality of corporate profits and elevated profit margins were dismissed as companies influenced by activist shareholders would mask the evolving headwinds with share buybacks, which, in the fullness of time, served to leverage the one relatively remaining healthy sector: American business's balance sheet. (Look back at the prices that General Electric ( GE) and HP ( HPQ) paid for their shares in buyback programs back then. It will make you sick! GE and HP shareholders suffered the hangover effect of the poorly timed buybacks!)

As legendary hedge fund manager Michael Steinhardt said in a 2007 interview with HedgeFolios, "As expected, once companies are faced with having to discuss their quarterly performance, we get a new round of share repurchase announcements." He pointed to Sears Holdings ( SHLD), which lost more than 7% after it came out with a warning that "almost halves the analyst estimate for earnings and magically a $1 billion increase in its buyback is announced.... Clearly, not every buyback is being used to cover for operational deficiencies, but when a company is struggling to sell products at good margins, that should be more important than a decline in share counts."

Another legend -- this one of a baseball kind -- pitcher Satchel Paige once said, "Age is a case of mind over matter. If you don't mind, it don't matter." As I wrote in 2007, for a while, the metamorphosis of the credit cycle was ignored: Investors didn't mind -- stocks had risen in 15 out of the last 18 months. Market participants, however, ultimately got a lesson in history.

In retrospect, the 2007 economy (discussed in my old column) and the leveraged foundation of the markets' dominant investors (hedge funds) represented nothing more than a house of cards. And I don't mean baseball cards!

Joltin Joe' has left and gone away?
Hey hey hey, hey hey hey.

-- Simon and Garfunkel, "Mrs. Robinson"

My advice? Similar to Major League Baseball records, be mindful and respectful of the history of credit and stock market cycles.

This certainly does not mean that anything close to an economic Armageddon or stock market crash lies ahead (similar to what occurred in 2008-2009); it does mean that the economic ride will be increasingly lumpy and that the stock market ride will become increasingly bumpy.

Similar to 2007, in 2012 the era of free and easy money is coming to a close at the same time as our recovery is growing increasingly fragile.

But 2012 doesn't rhyme with 2007 - it's different this time, with secular challenges that present unique headwinds to a self-sustaining domestic economic recovery.

Consider that today's challenges, in some ways, are more problematic than those that were encountered in the last cycle. The problems in 2007 were patched up by bailouts and massive easing, and it took only two (very painful) years for the wounds inflicted by the early 2000s to appear to heal.

Today's challenges (fiscal imbalances, structural unemployment, etc.) suggest a more lengthy period of rehabilitation as the solutions to these problems cannot quickly be dispatched, as they are our inheritance from the last cycle and, maybe even, a decade or two of risk and debt accumulation before that.

So, remember for the future, if you don't pay attention to Mr. Market's history, it could be, "one, two, three strikes, you're out, at the old ball game!"
At the time of publication, Kass and/or his funds had no positions in any stocks mentioned.

Doug Kass is the president of Seabreeze Partners Management Inc. Under no circumstances does this information represent a recommendation to buy, sell or hold any security.

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