Kass: A Critical Juncture

This column originally appeared on Real Money Pro at 8:33 a.m. EDT on July 6.

NEW YORK ( Real Money) -- It is becoming increasingly clear that global easing (both in the U.S. and abroad) is losing its marginal benefit and that the onus of economic and corporate profit growth lies squarely on the shoulders of fiscal policy. The likelihood of fiscal inaction and the associated policy uncertainty (taxes, monetary and regulation) are about to weigh down corporate results (possibly for some time).

The stock market has been beholden to central bank credit creation for years. In the past few years, it is clear that QE and other central bank schemes are the biggest props under stocks and commodities. Gasoline and other fuel consumption have declined sharply over the past few years, yet prices have soared on QE and ZIRP. This dynamic has occurred in other commodities, and it prevents market forces from producing price equilibrium and a normalized economy.

Now, the winds of recession are increasing in intensity across the globe. The grand fight between central bank debt monetization and the natural order of economic cleansing is about to enter a deeper, darker circle of hell.

-- Bill King, The King Report

Over here (of course), dysfunctional politicians are unable to put their differences on the back burner in order to address the fiscal cliff and to implement thoughtful, outside-of-the-envelope fiscal pro-growth initiatives.

Over there in the eurozone, hard-hitting and sometimes painful fiscal initiatives are being delayed in favor of more Band-Aids (cowbell and easing). The overseas markets are starting to see through those temporary patches.

Already, the euro has given up all its gains since last Thursday's economic summit in Brussels. As well, yields on Spanish and Italian bonds are again backing down, with Spanish sovereign debt back close to 7% -- it peaked at 7.07% -- and up 13 basis points overnight. In Italy, the rise in yields is even more conspicuous, with yields up by 26 basis points, to 6%, this morning.

Before the year began, I was hopeful that this would be different (i.e., that policy would be less uncertain), but as we move ever closer to the November elections, any movement away from the currently divided and divisive behavior is increasingly unlikely. The behavior and inaction of our leaders in Washington, D.C., has been a downer for business and consumer confidence, and now the profit picture is eroding (posthaste) in the face of that understandable deterioration in confidence.

Consensus forecasts (implicit in $100-plus-per-share 2012 S&P 500 earnings) are for about 5% year-over-year growth in profits in second quarter 2012 and for about 6% growth in this year's second half.

As organic sales gains slow coincident with a deceleration in worldwide economic growth, these projections, based on the early warning signs -- namely, from the likes of Nike ( NKE), Procter & Gamble ( PG), Caterpillar ( CAT), Ford ( F), General Motors ( GM) and others -- and continued policy inaction and uncertainty, are now in jeopardy.

Despite trillions of dollars in global easing, the ISMs and other pervasive reams of economic data signal that growth is slowing relative to expectations.

Yesterday's June retail sales were generally soft relative to expectations, with the high end notable in its weakness.

Tech, which is particularly exposed to a European slowdown and the strength in the U.S. dollar, has hit the skids, with unit growth expectations for personal computers, smartphones, chips and disk drives being revised lower. For example, both Seagate Technology ( STX) and Informatica ( INFA) reported poor results and lowered guidance after the close of trading last night. Informatica, a data integration company exposed to the cloud, was particularly disappointing, and the shares tumbled by 26% in after-hours trading.

I am growing increasingly concerned that not only are consensus 2012 profits in jeopardy but that next year's outlook for earnings could be revised lower as well.

Many who worship at the altar of price momentum are growing more bullish (along with somewhat higher stock prices), and we are at a critical juncture in the U.S. stock market.

The optimists mostly cite that valuations are undemanding, but we all know that valuation is a poor timing tool. Given the lower profits prospects for 2012-2013 and the persistent and growing policy uncertainty in the U.S. and eurozone, we should recognize that the traditional valuation relationships of stock prices relative to the economy, earnings, interest rates and inflation have lost some of their relevance.

At the time of publication, Kass and/or his funds were long F and GM, 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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