Rag Doll; Taking Another Crack at Citi: Best of Kass

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.

Last week, Kass wrote on a possible shift in market conditions and on Citigroup.

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Rag Doll
Originally published on Friday, July 25, at 7:22 a.m. EDT

(Rag doll, ooh)
When she was just a kid, her clothes were hand-me-down
They always laughed at her when she came into town
Called her rag doll

-- The Four Seasons, "Rag Doll"

Despite headline records, market conditions (subsurface and not-so-subsurface) could be turning, and my net short exposure reflects my concerns.

    • We have a bull market in stocks but also in complacency (a self-satisfied view that fails to take into account adverse outcomes).
    • There are technical divergences aplenty (the beneficiaries of the market melt-up are narrowing).
    • Bears have become an endangered species, and some measures of investor sentiment are at a bullish extreme.
    • The fuel of corporate buybacks (junk bonds) is starting to retreat from bubble-like conditions.
    • Geopolitical risks are multiplying geometrically.

[Read: IMF Sees U.S. Growth at Weakest Since Recession]
  • The domestic economic recovery has been an exclusive one.
  • Stock valuations (adjusted for normalized profit margins) are well above the historic averages, and financial engineering may not steer us to higher P/E multiples forever.

We are five years from the Great Recession, and aggressive easing by central bankers around the world is still needed to sustain economic growth. Confidence and faith in the ability of the Fed to exit neatly remains one of the biggest bubbles extant.

Corporations' and individuals' dependency on low interest rates is not likely fully appreciated by market participants. (Just look at the U.S. housing market.) Buying all (even shallow) dips and dismissing short-selling as a mug's game have become entrenched strategies -- signals that, contrarily, risks are rising.

[Read: Where the Housing Bubble May Be About to Burst]

Thirty-five months without a meaningful correction is an excess itself.

It has become downright embarrassing for the cautious among us. Toward that end, a longtime and well-respected bear, technical analyst Sue Berge, gave up the 10% correction call this week.

Seasonality might also be a concern, as historically, markets often run into trouble in the July-to-October period. July and/or August highs are commonplace in the modern investment period. Some of the more serious examples developed in overbought markets in periods such as 1929, 1937, 1946, 1957, 1987, 1990 and 2007. Between now and November, investors and traders face atypically large uncertainties, including:

  • again, rising geopolitical issues
  • a Fed that is ending its bond purchases and is considering an interest rate rise
  • a potentially divisive midterm election that will set the stage for legislation in the years ahead.

To summarize, segments of the market are beginning to wear out, and certain conditions that have led to low volatility and an unrelenting bull market are looking like a rag doll.

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