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.

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