My 'Fast Money' Recap

This column originally appeared on Real Money Pro at 8:26 a.m. EDT on April 5.

NEW YORK ( Real Money) -- Last night, I was on "Fast Money" with Melissa Lee, Tim Seymour, Guy Adami, Pete Najarian and Karen Finerman.

The message I presented last night was that the liquidity rally (in place for several years) was over and that it's time for Mr. Market to meet Mr. Gravity!

Let's go to the tape!

I started off by expressing the view that the U.S. monetary cliff (and the conclusion of quantitative easing) at June's end has suddenly grown more conspicuous with the publication yesterday of the FOMC minutes and it should scare investors in a lot of risk asset classes.

In response to a question by Tim about how large the consequences are , I said that when economies stumble (as they did in 2008-2009), public fiscal and monetary policy comes to the fore and defends against an acceleration of economic and corporate profit weakness, inhibiting natural price discovery. This is now being reversed, and absent more easing, investors are now going to experience a natural price discovery in stocks, bonds and gold -- with all those asset classes moving lower in price.

The Bernanke put might be still out there, but it now is far more out-of-the-money than the markets believed prior to yesterday's release of the FOMC minutes. I would argue that, especially as we move ever closer to the November elections, more easing is an idle threat by the Fed to create the illusion of a Bernanke put for equity prices. After all, what politician or Fed member would be willing to risk more easing, which could create a ramp up in gasoline prices at election time?

What also has me concerned with regard to stocks is that, at a time in which monetary policy might be more neutral, we are seeing more ambiguous signs of slowing domestic growth:

  • Warm weather has pulled forward retail sales.
  • The 100% tax credit, which expired on Dec. 31, 2011 and has dropped to 50%, has likely pulled forward business spending.
  • Though the labor markets are in a clear recovery (off of a low base), other indicators are more ambiguous -- factory orders, industrial production, durable orders and personal income are disappointing, while aggregate manufacturing inventories such as autos (at General Motors (GM), in particular) are high. Wednesday morning, the ISM monthly services report disappointed, and, as Sir Art Cashin pointed out, the orders and backlogs were especially weak.

In response to Guy's question as to what investors might be missing, I suggested that the ramifications of U.S. political policy are underappreciated. The political gridlock now and likely after the election could result in an undesirable and growth-deflating rise in interest rates, even if the economy only muddles through. Already, refinancing activity is down in six of the last seven weeks. And refinancings serve as a source of consumer comfort (and spending) and could slow down the nascent recovery in housing.

Overseas, the European recovery is very fragile and could impact U.S. multinationals exposed to the region.

Prior to Wednesday, the S&P 500 had but one day in which it declined by 0.7% or more; it's worn out every short-seller -- so there is no latent demand to cover shorts -- at a time in which hedge funds have been raising their exposure.

In response to a question from Karen, I asked, with all these concerns, where is the incremental buyer that is going to take us to 1500 in the S&P? It's not going to be retail investors, who have stayed out. They have been hit with a 34% drop in home prices, two market crashes in the last decade, a flash crash, and their incomes are not keeping up with inflation. The last thing on their minds is to buy stocks!

Finally, this potential growth slowdown could be occurring at a time when U.S. corporate profits are trending at all-time highs (at 57-year highs) and are vulnerable. Remember, unit labor costs are up by over 3% in 2011, up from 2% and 1% in prior two quarters. The nominal PPI is greater than the nominal CPI, and the only number above 60 in Wednesday's ISM services report was prices paid. All these factors suggest profit margin regression back towards the mean as likely.

So why should I or any other investor pay nearly 14x for record-high profit margins when the last five decades have averaged only 15x and we didn't face structural unemployment and massive fiscal balances?

It should be mentioned that there are positives -- most notably, the drop in crude oil prices and in natural gas prices. And the warm weather of this past winter has led to lower energy usage. Also, it is my strong belief that housing is about to embark upon a durable, multiyear recovery (and the multiplier impact on the economy is great).

In response to Melissa, my investment conclusion is that real interest rates are going to begin to rise. Bonds should be sold or shorted, gold should be avoided, and stocks probably are vulnerable as well (by 5% to 8%). Raise cash and be defensive. Avoid interest-sensitive areas in the market and companies that have a lot of variable rate debt.

Put your money in defensive areas such as consumer staples that can boast large free-cash-flow generation, dominant global franchises (with protective moats), reasonable dividend yields and low (relative to historic standards) P/E multiples. Shares of Clorox ( CLX), Colgate-Palmolive ( CL), PepsiCo ( PEP), Procter & Gamble ( PG) and International Flavors & Flavors ( IFF) have excellent risk/reward ratios.
At the time of publication, Kass and/or his funds were long CLX, CL, PEP, PG and IFF common and long IFF calls., although holdings can change at any time.

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.