Kass: Short-Term Market Outlook Improves

(This column originally appeared on Real Money Pro Tuesday, Sept. 3 at 7:58 a.m.)

"We have a lot more to go on the upside...  We made the low on June 24th... I love the leadership, guys. Take a look at secondary stocks which are leading the markets -- its not Blue Chips. And  the transports are on fire, we cant get any better than that... It's up up and away... . The Russelll 2000, its very impressive,  it's 2000 stocks vs. the thirty  Dow stocks. It's very impressive guys! ... The March, 2009 low was comparable to the August, 1982 low and that was the beginning of an eighteen year secular bull market.... we are only 4 1/2 years into a secular Bull Market. We are at all time high. There is no supply overhead and there is great leadership..Hello? It doesn't get any better than this. Come on guys we have a lot more upside... Why are you neutral on stocks, Brian? Buy high and it's going higher, Brian (Kelly)...Guys,  I cant believe you, in the early 1980s everyone complained too, all the way up. Enjoy it, enjoy it. "(Note: Ralph Acampora had a 17,000 Dow Jones Industrials target for year end at the time of this interview).

-- Ralph Acampora July 9, 2013 CNBC Fast Money

"Let me just talk about the technicals.... When good news can't take the market up is bad news... I took a good look inside the Dow Jones Industrial Average- it's months of churning ... You have to be careful..I tell my friends who participated should take a profit...(Note: One month earlier, while stocks were "churning" Acampora was confidently bullish)."

-- Ralph Acampora August 16, 2013, with CNBC's Maria Bartiromo "I just want to say something, Bill. My concern started three or four months ago. Step back and look at weekly bar charts. You have seen a lot of very heavy blue chip stocks. It is not a pretty picture. Even secular bulls have bear markets...This could be a difficult period...I am sorry I totally disagree (with your bullish guest), I can't turn my back on large cap stocks...if McDonald's and  IBM and others drop, near term don't fight Papa Dow." (Note: Acampora now looks for the DJIA to move to the 12,000 area - which is a 5,000 reduction in his year end forecast since early July)!

-- Ralph Acampora, August 30, 2013 with CNBC

If uncertainty is represented by a wall for the markets to climb over, there is certainly a tall wall ahead.

From my perch, the quotes above, in three separate CNBC interviews, by legendary and well-regarded technical analyst Ralph Acampora capture the evolution of an increasingly downtrodden view of the markets over the last few months by traders and investors. 

Let me emphasize that I am not picking on Acampora's reversal over the last 45 days, nor am I making an ad hominem attack on the guy. Rather, I am demonstrating the general change in sentiment that has so swiftly occurred. (But a 5,000 point, or 30%, reduction in his DJIA price target, with only four months to go in the year seems to be extreme and at odds with the strong self confidence he expressed when he was correspondingly bullish in July and now bearish in August).

Back in mid-August, in " Beware of the Momentum Cult," I cautioned readers to beware of those who worship at the altar of price momentum. Because, in the main, they are a fickle bunch who often suck investors in with their confidence just at the wrong time.

Here is an excerpt from that column:  

"Simply watch Bloomberg or read Tweets and daily newsletters today, and you will find even the most glib and self-assured bulls turn on a dime when stock prices move south. It's almost as if they had no memory what they said or wrote the day or weeks before!

I recently wrote about the growing self-confident bullish investment community. Unfortunately, most of the lot are technically oriented day-traders who never even looked at the companies' balance sheets or income statements before exclaiming their enthusiasm for the issues/stocks. They are mostly trend-followers who worship at the altar of price momentum.

Following prices and gazing at charts makes for an easy, simplistic and necessary strategy for a business commentator, strategist or investor who spends much of his time preparing for media engagement.  This is why it is important to do your own homework -- as Jim "El Capitan" Cramer  (who is a clear exception to my characterizations above!) implores  you to -- and come to your own independent investment conclusions.

And the theme of this column also applies to my musings as well as the others!"

My call for a market top in early August had numerous fundamental and technical reasons for it. As contrasted to the confidence of others, my forecast included words like possible, likely and contained other caveats appropriate with any strong and out-of-consensus forecast. (I try to always qualify my view and to demonstrate the lack of certainty of any forecast because I have the scars on my investment back that went along with my hubris and, ultimately, my misguided market prognostications of the past)

The lack of attention to some obvious warning signs, like the technical threats of churning and eroding breadth or the weak top and bottom lines of corporations in 2Q 2013 was, at the time, confusing to me when I made my top call in early August.

As always, the true contrarian embraces uncertainty optimistically, reasoning that most of these concerns have been incorporated and digested in the recent market weakness. To me, this means that if any of these negative catalysts feared by an increasing body of market players actually occur, their market impact may be anticlimactic.

Here are some of the well publicized headwinds of the last few months that I have highlighted.
  • Global Growth Slows -- Mixed and uneven data suggested that global economic growth headwinds would not result in the expected second-half acceleration in GDP.
  • Emerging Market Concerns -- Investors, anticipating higher U.S. interest rates, have disintermediated emerging markets, serving to rock the economies of countries that rely heavily on foreign investment (e.g. Indonesia and India).
  • QE Loses It's Effectiveness -- Growing evidence that excessive easing is a blunt tool to catalyze growth.
  • Fed Tapering -- It has grown increasingly likely that a September tapering is in the cards.This, too many (including myself), would qualify as a policy mistake (owing to the domestic economy's inability to reach escape velocity.)
  • Still Tepid EPS Growth -- Disappointingly slow corporate profit and sales growth, particularly excluding financials.
  • Rising Interest Rates
  • Valuations Stretched -- Expanded price earnings multiples in the face of weak sales and earnings growth.
  • Growing Geopolitical Risks -- The growing likelihood of a U.S. military attack on Syria.
  • A Divided Washington D.C. -- A heated debt ceiling debate looms ahead.
  • An Imminent Tapering -- Subject to data.
  • The Fed -- Uncertainty as to who will be the next chairman of the Federal Reserve.
  • Weak Technicals -- There were numerous troubling technical signs that were being ignored.

While I continue to subscribe to the notion that the year's market high has been put in, the contrarian in me says the markets could lift somewhat (and could even threaten the July highs) and certainly not drop precipitously (as many increasingly expect) during the months of September and October. (Already the Asian and European markets, as well as our S&P futures, are responding well to the president's decision on Syria and to the economic data in the EU and China).

Being Bearish over the intermediate term, as I still am, does not mean there won't be trading opportunities on the long side - though brief it might be.

One such trading opportunity could be upon us now.

Some Headwinds Have Now Become Modest Tailwinds

At the core of my slightly-more-constructive near-term view is the administration's "go slow and go limited" policy in Syria (Note: In " Syria, Oil and Global Markets" I suggested that Syria would not be a serious impedient to the stock market's potential advance), some recent strengthening in global growth data and, as characterized in my opening quotesof Ralph Acampora, a sharp pick-up in negative sentiment from talking heads, technicians, strategists and business commentators.  

I strongly suspect, with the aforementioned headwinds, some bad bearish bets have been put on as cash reserves have been increased by the dominant investors (hedge funds) as well as other institutional investors.

On Syria, the President's surprising decision (to investors and to his advisers) to seek a Congressional authorization for a military strike can be viewed as a market positive. (While debate will start this week, a vote in Congress will not likely occur until the middle of next week). 

While Syria has gained the headlines, several measures of economic growth have modestly improved (albeit not enough to encourage me to materially change my economic and earnings outlook for the balance of this year and for 2014). 

This includes the final August eurozone manufacturing index released yesterday morning. It came in at 51.4 compared with the flash estimate of 51.3 and July's reading of 50.3. This is the best print since June, 2011 and it was broadly based (with forward looking orders up 2,5 points and at the highest reading since May, 2011 and with orders/inventories widening). To be sure, the European economies are emerging from a lengthy recession, but at least growth has stabilized.

In China, the August Manufacturing Index climbed to 51.0 compared with expectations of 50.6 and with July's 50.3. This is the best print in nearly 18 months. Again, like the eurozone, the most forward-looking component, orders, was stronger than generally forecast ,with export orders finally above 50 (indicating expansion expected).  Orders and an increase in export orders to a level above 50 (indicating expansion for the first time since March, 2013) are consistent with 7-7.5% real GDP growth for China. 

Like many, I am skeptical of the Chinese data. But the non-government data reflected in August's HSBC/Market Manufacturing Index has risen to more than 50 from only 48 in July. This, coupled with an increase in commodity prices over the last two months, confirms China's stabilization of growth. Importantly, these data suggest that China's focus to rein in the excesses in the shadow banking system are not denting economic activity. This dulls the potential (big) risk that emerging markets economic weakness results in a further liquidation of EM positions (stocks and bonds) through the shorting of more liquid assets like the U.S. market. 

Most Headwinds Will Likely Cap This Rally Short of July Highs

I should emphasize that I don't see anticipated relief in the September-October market climb to carry it above the year's recent highs.

The most significant challenge to the market's highs includes continued weak domestic and global economic data (led by a stall in the U.S. housing market), this year's previous expansion in valuations, a challenging profit landscape and an imminent confrontation regarding the debt-ceiling issues.


Though it remains my view that the 2013 market top is likely in, over the near term I expect global equities to rally and for gold, oil and fixed income instruments to be under pressure. 

Factors favoring a short-term advance into a month that has historically been a weak period (September (according to BTIG's Dan Greenhaus "is the only month of the year which does not produce positive returns more than 50% of the time although recent Septembers have generally been positive)" include moderate improvement in manufacturing activity, which turns the headwinds of  Europe and  China into modest tailwinds. As well, sentiment had deteriorated as technical damage has been magnified in the face of lower stock prices (both in the emerging and developed worlds). Finally, the administration's actions towards debate with the House and Senate is also a modest positive.

At the very least, the factors mentioned in today's opening missive will contain the market's downside. At best, September-October could be surprisingly good months for the equity markets.

Color me slightly more upbeat and willing to trade from the long side as well as the short side now, in  more of a two-way market setting.

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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