Kass: Super Mario Buffers

This column originally appeared on Real Money Pro at 8:34 a.m. EDT on Sept. 6.

NEW YORK ( Real Money) -- This morning, in response to a plan already telegraphed last weekend by Mario Draghi to buy short-term sovereign debt of ailing countries, the S&P 500 futures advanced by 9 handles.

I plan to sell/short this news for several basic reasons:

  • Not only is Europe slipping more rapidly into a deeper recession but the implementation of serious and effective longer-term policy responses remains unlikely. Band-Aid policy measures of providing liquidity (which aids the transmission of monetary policy) remain the operative palliative, and they will likely continue for some time to come. Easing and the temporary purchase by the ECB of sovereign debt from peripheral countries will not durably counter insolvency but, ultimately, the solvency problem will be addressed by a painful debt restructuring. While Europe is geographically united, it is culturally and politically diverse, and a surrender of national sovereignty to the required extent necessary is unlikely. In time, the euro will probably be pulled apart as tensions increase across geographic and socioeconomic fault lines. In other words, there will be many more Thursdays with Mario.
  • While Draghi's plan will temporarily aid the transmission of monetary policy, we can look at the massive doses of monetary stimulation in the U.S. as a template. Despite unprecedented easing, we are now more than three years after the Great Recession of 2008-2009, and the domestic economic economy is growing (in real terms) at only 1.8%. Given the more dire state of the eurozone (accelerating inflation, decelerating economic growth and rising unemployment), how will it be possible for Europe to grow out of its debt problem? The answer is that it won't be able to without the heavy lifting and unpopular policies that could encourage growth by cutting expenditures and balancing trade. And I am concerned that Europe's wave (and deteriorating growth prospects) will crash on our shore in the year ahead, rendering vulnerable consensus forecasts for 2013-2014 corporate profits.

Looking beyond our noses, higher stock futures and Mario's efforts, I remain of the view that the U.S. stock market could be tracing a triple-top and that it is quite possible that the year's highs have already been seen.

U.S. stocks are trading at about 14x consensus 2012 S&P 500 earnings expectations, seemingly attractive when compared to a five-decade average of slightly more than 15x and against historically low interest rates (risk premiums remain high). But given current (inflated and vulnerable) 65-year highs in corporate profit margins, downside risk to U.S. corporate profits in 2012-2013, the threat of a steepening fiscal cliff, a still-tepid muddle-through domestic recovery susceptible to external shocks, a destabilized eurozone destined for years of subpar economic growth, the likelihood (according to most polls) that the Democrats will regain the presidency and maintain control of the Senate, the increasing possibility of a harder landing in China, escalating hostilities in the Middle East (and its implications for rising oil prices), continued weak fund flows by individual investors into domestic equity funds and an increase in bullish sentiment, I see little chance of P/E expansion and a rising possibility of P/E contraction.

"Whence it follows that the bad economist pursues a small present good that will be followed by a great evil to come, while the good economist pursues a great good to come, at the risk of a small present evil."

-- Frederic Bastiat, "That Which Is Seen and That Which Is Unseen"

From my perch, investors are not being traditional in their investing; they are instead depending and are guided by their reliance on effective stimulative policy (and a global easing put).

Risks are high of policy disappointment.

And as long as the eurozone fails to address formidable and persistent cyclical and structural economic growth concerns, sell the news.
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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