Kass: Ignore the Macro? Not Me!

This column originally appeared on Real Money Pro at 9:21 a.m. EDT on May 14.

NEW YORK ( Real Money) --

"If ignorance is bliss, then knock the smile off my face."

-- Rage Against the Machine, " Settle for Nothing"

According to Merrill Lynch's May global fund manager survey (230 investors with $660 billion in assets under management) released last night, hedge funds are at their highest net long exposure in seven years.

Clearly, this dominant class of investors (and others) is now dismissing concerns regarding the macroeconomic backdrop in the U.S. and around the world as poppycock.

Many (on this site and elsewhere) are now saying that the tepid global economic growth is something that big-picture economists and strategists worry about, not stock pickers.

They go on to say that the disconnect between world GDP and share prices is almost an academic argument. They almost suggest that it is a distraction for worrywarts, who would be better off analyzing company-specific or microeconomic data.

While there is some truth to the bulls' arguments, I am less convinced that one should totally ignore the macroeconomic conditions.

As I have recently written, slow nominal GDP growth represents a challenge to corporate profits -- the mother's milk of the stock market.

Bright Spots

Recently, there have been some bright spots. Oil prices have slipped. Jobless claims have trended lower, and the outlook for employment has improved. The labor force is expanding somewhat, and temporary jobs growth has turned up but possibly for the wrong/bad reasons (related to Obamacare).

Negative Forces at Work

Nevertheless, there are forces at work to suggest that first quarter 2013 will mark a peak in U.S. real GDP for the year. The last three quarters of this year will likely show a moderation of economic growth, producing weak nominal GDP that will fail to provide corporate pricing power, will jeopardize already-inflated profit margins and will deliver corporate profits well under consensus expectations.

Housing: Hedge funds and other corporate and institutional investors have gobbled up homes for investment. This has served to prop up home prices, which, in turn, has served to turn away first-time homebuyers. I expect a pause in my anticipated durable multiyear recovery in housing.

Jobs: While unemployment claims have begun to improve, this volatile series likely benefited from continued Superstorm Sandy reconstruction. Moreover, the improvement appears to be mostly in lower-paying jobs.

Oil price: After a several-month-long drop in gasoline prices, the price of crude oil seems to have stabilized and has started to move higher over the last two weeks.

Federal budget deficit: A near-term improvement in the U.S. budget deficit could be bad news for the sequestration, as our leaders become less willing to negotiate anything in the budget, and that could portend a big debt-ceiling debate/fight.

Currencies: The profound weakness in the Japanese yen will temper the manufacturing export growth of some of our largest international corporations that importantly serve non-U.S. markets. This could stall jobs growth and capital spending expenditures and plans.

Quantitative easing: This morning, Appaloosa's David Tepper was optimistic based on the Fed's continued printing. The Fed has printed about $1 trillion, and this year, the U.S. exchange's market cap has risen by $2.5 trillion. That is quite a lot of bang for the Fed's buck! In other words, Tepper says that the Fed's printing press is going into stocks -- and will continue to do so. But the stock market wealth build already well exceeds the expected 2013 EPS growth -- plus the $1 trillion of fresh money printing. To me, The Wall Street Journal column on Friday night by Jon Hilsenrath was a shot across the bow to prepare investors for "halting steps" in printing. I expect that the Fed could pause/taper in the second half of 2013. If so, interest rates will rise, providing a headwind to interest-rate-sensitive domestic economic sectors and result in more competition to equities.

Summary

Today's opener focuses on the prospects for subpar domestic economic growth. The outlook for Europe and China remain even more uncertain than the U.S.

The S&P 500 is up 15% this year, as P/E valuations have been revised higher. This has occurred in the face of flat sales, about a 2.5% increase in corporate profits and profit margins that are about 75% above the long-term average.

I continue to view corporate profit growth expectations, in the aggregate, as too optimistic and stocks as overvalued.

At the time of publication, Kass and/or his funds had no positions in the stocks mentioned, 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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