NEW YORK (TheStreet) -- Doug Kass of Seabreeze Partners is known for his accurate stock market calls and keen insights into the economy, which he shares with RealMoney Pro readers in his daily trading diary.

Among the posts this past week were entries about the need for greater-than-usual caution and GDP and jobless data.

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No Memory Day to Day

Originally published on Friday, Jan. 31 at 6:59 a.m. EDT.

The thrust of my diary's opening missive on Thursday was that the month of January represented (1) a challenge to many of the consensus expectations for 2014; (2) a scenario in which the investing and economic backdrops have changed (and not for the better); and (3) the notion that risk (and contagion) happen fast.

The major market indices will almost assuredly close the month in negative territory. The January barometer states that "as January goes, so goes the full year." While I am not much of a believer in that technical voodoo, I would note that the theory has been correct for 73% of the last 85 years.

To this observer, January could represent an important inflection point and watershed for the markets.The month's performance is consistent with my expectation that the S&P 500 will suffer a 5%-15% drop in 2014. its first drop in five years.

Overnight the markets failed to carry over with the prior day's strength, which has been a typical occurrence throughout the last four weeks in a market that I have described as having no memory from day to day.

Thursday's price action was strange. As it is said, "play on, player." The new economy stocks ripped the shorts' heads off during the regular session, led by Google (GOOG - Get Report) and Amazon (AMZN - Get Report) in anticipation of earnings. Amazon disappointed and is trading lower by about $20 a share, or 6%, while Google's shares have hit an all-time high, rising by $40 a share, or 3%, in extended-hours trading. At the same time, the financial sector lagged, representing, to me, a worrisome sign that Thursday's strength could be short-lived.

Equally disconcerting, as risk assets climbed on Thursday, Treasuries (despite the announcement of a continued taper earlier in the week) also rose across the curve. Yields have followed through to the downside this morning and the yield on the bellwether 10-year has breached the 2.70% level.

The DAX is leading the European indices and is down by nearly 1.50%, putting the year-to-date drop to more than 3%, and S&P futures are 14 handles lower.

This article describing bank regulator requirements for capital might be the proximate cause for the EU share price weakness.

The Nikkei continues lower.

Yesterday's opener bears repeating. It started with the reiteration of one of my "15 Surprises for 2014". (Note: Many of my surprises have already surfaced in the first four weeks of the year).

Here is a synopsis of my commentary from Thursday:

Surprise No. 13: Africa becomes a new hotbed of turmoil and South Africa precipitates an emerging debt crisis.

Politics and economics form a potentially toxic cocktail.

Africa triggers an emerging-market crisis and becomes a flashpoint of geopolitical risk and political turmoil as the region's untapped oil wealth is recognized. 

Not long ago, South Africa was meant to be the "S" in the BRICS, alongside fast-growing Brazil, Russia, India and China. The rand, however, is in steep decline, and the nation has growing budget and trade deficits and slowing growth, so it can hardly claim membership in that club right now.

At some point in 2014, the ratings agencies will downgrade South Africa, foreign money will flee, and the country will be in a full-blown financial crisis that will trigger a wider selloff in the emerging markets and could highlight problems at emerging-market central banks (which are already suffering from slowing economic growth, an acceleration in inflation, etc.).

Potentially changing regimes due to national elections in Brazil, India, Indonesia and Turkey cause those countries to join South Africa in the emerging markets' bumpy ride, which is further impacted by U.S. dollar strength caused by the Fed's tapering.

If the crisis intensifies and expands beyond South Africa, a contagion into the developed banks could raise additional concerns and pull down money center bank shares.

-- Doug Kass, "15 Surprises for 2014"

Risk and contagion happen fast.

Usually the crowd outsmarts the remnants, but we should always beware of turning points!

It is helpful, particularly in periods of complacency (and in aging bull markets) such as we faced late last year, to consider out-of-consensus surprises and events that could unexpectedly influence the markets.

That is probably why Byron Wien started his surprise list years ago, and it is why I started mine and mimicked Byron's a decade ago.

Arguably, this whole global market downturn in January has been the outgrowth of complacency and that most were already in the pool -- in other words, progress was discounted in valuations (which rose an outsized 24% in 2013).

Consider the strong consensus views as we entered 2014:

  • Japan, which is now down 8% year-to-date, is the best region in which to invest;
  • stocks will outperform bonds;
  • the rate of global economic growth will accelerate;
  • interest rates will rise.

And there's more, but let's keep this list contained.

By contrast, the risk of contagion was an important theme in my surprise list for 2014 (see surprise No. 13 above); it was a risk that was ignored by many. Indeed, few risks were considered following the outsized market gains last year, a sentiment that is embodied in Adam Parker's quote below.

"The only thing people are worried about is that no one is worried about anything.... That isn't a real worry."

-- Adam Parker, chief U.S. strategist at Morgan Stanley

The baton handoff from Helicopter Ben to Whirlybird Janet has initialized an effective tapering, and monetary policy is in the process of being normalized.

In light of that tapering has already come a swift price discovery in the capital markets, a price discovery that had previously been sabotaged by the massive bouts of liquidity delivered by the world's central bankers.

The key issue over the next few months is whether the problems and contagion in the emerging markets impacts the developed markets.

I reached out to a good friend who is among the best in the macro world -- I don't have permission to name him, but you all know him -- who expressed the case for a containment of contagion, which is presented below.

  • The currently troubled emerging market regions represent a minor portion of global GDP and S&P earnings.
  • While the economies in the emerging markets are slowing, the economies of Japan, Europe and the U.S. are expanding.
  • Central banks of troubled emerging market countries understand the risks and are easing.
  • Emerging stock markets have massively underperformed already, suggesting a lot has already been discounted.
  • External debt/GDP ratios are not problematic, and foreign-exchange reserves are ample relative to imports.

Nonetheless, to this observer, Turkey is likely the tip of the iceberg of that discovery, for, as Warren Buffett once wrote, "Only when the tide goes out do you discover who's been swimming naked."

Whether or not this is the end of the five-year bull market is uncertain.

What is certain is that the investing and economic backdrops have changed -- and not for the better.


I strongly believe that the market outlook over the next few months dictates greater-than-usual caution.

Volatility and uncertainty remain my baseline expectation.

Opportunistic trading will likely trump buy-and-hold investing.

Shorting (though not for everyone), so unpopular since the generational low in early 2009, could gain in popularity.

Some examples of shorts in my book include Starbucks (SBUX - Get Report), MetLife (MET - Get Report), Lincoln National (LNC - Get Report) and, though I have recently covered it, IBM (IBM - Get Report).

In terms of asset classes, my favorite sector to be long is the closed-end municipal bond funds (already up 10% during January 2014).

Above-average cash reserves and less-than-typical-sized positions seem prudent in a market without memory from day to day.

At the time of original publication, Kass was short SBUX, MET and LNC.

Parsing the Data

Originally published on Thursday, Jan. 30 at 9:30 a.m. EDT.

U.S. GDP in the fourth quarter of 2013 expanded by 3.2%, exactly in line with expectations after a 4.1% gain in the third quarter.

Personal spending was up 3.3%, though that was less than the estimated gain of 3.7%, but it did contribute 2.25 points to GDP growth.

There was another lift to inventories that helped to drive growth. After rising by $115.7 billion in the third quarter, inventories rose by another $127.2 billion in the fourth quarter, the biggest gain since 1998.

The slowdown in residential construction was reflected, as it fell 9.8% after double-digit gains in the previous five quarters. Spending on equipment bounced back to 6.9% from little change in third quarter, and intellectual property saw another good gain.

Trade was a big boost to GDP, as exports rose 11.4% and imports were up just 0.9%, adding 1.33 points to GDP.

Government spending was a drag, solely at the federal level in response to the government shutdown.

Bottom line: It was consumer spending and trade that contributed the most to growth and the real final sales gain of 2.8% was the best since the first quarter of 2012. With an expected slowdown in the inventory build in first quarter, GDP growth should moderate back to the 2.5% level this quarter. Also, with the emerging market foreign exchange turbulence in recent weeks, we'll be watching closely what impact it has on exports.

Initial jobless claims totaled 348,000, 18,000 above expectations, and last week was revised up by 3,000, to 329,000. The four-week average was little changed at 333,000 vs. 332,000, but today's number follows three straight weeks that ranged from 325,000 to 330,000.

Continuing claims fell by 16,000, and because unemployment insurance was not extended, there are no more extended benefits.

Bottom line: Today's figure is a bit of a disappointment, as it's the highest since mid-December. In terms of the Fed and its taper program, Whirlybird Janet has two more payroll reports to see before the March meeting.

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.