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Kass: A Market Without Leadership

By Guest Author | April 30, 2018

, Kass: A Market Without Leadership

* More volatility lies ahead

“Our experience tells us that these leaderless periods typically occur during important transitions in the market. So what is that transition today and how can we harness it to make money? Sticking with our original thesis for 2018, we think the market is digesting the fact that the tax cut last year has created a lower quality increase in US earnings growth that almost guarantees a peak rate of change by 3Q. Furthermore, the second order effects of said tax cuts are not all positive.

Specifically, while an increase in capital spending and wages creates a revenue opportunity for some, it also creates higher costs for most. The net result is lower margins, particularly since the tax benefit is 100 percent ‘below the line.’ Now, with the pricing mechanism for every long duration asset- 10-year Treasury yields-rising beyond 3 percent, we have yet another headwind for risk assets.

Perhaps most importantly for US equity indices, these higher rates are calling into question the leadership of the big tech platform companies-the stocks that may have benefited from the QE era of negative real interest rates more than any area of the market. When capital is free, growth is scarce, and the discount rate is negative in real terms, market participants reward business models that can use that capital to grow. Dividends and returns on that capital today are less important with the discount rate so low. But, with real interest rates rising toward 1 percent, that reward structure may be getting challenged…2018 will mark an important cyclical top for US and global equities, led by a deterioration in credit. Narrowness of breadth and a lack of leadership suggest that this topping process is in the works and will ultimately lead to a fully defensive posture in the market later this year.” – Morgan Stanley

The market lacks clarity and trend – likely remaining in a broadly defined near term trading range of (S&P) 2550-2725.

For the full year I continue to expect a 2200-2850 trading range for the S&P Index in 2018, with a “fair market value” of about 2400.

With cash now at 2680 – adjusted for the 8 handle rise in the S&P Index – currently, there is about 480 S&P points of downside risk (to the low end of my full year trading range) and approximately 280 S&P points of risk to “fair market value” — as compared to the upside of only approximately 170 S&P points to the high end of my forecasted trading range.

Accordingly, the current S&P cash level has about 2.8x more risk compared to reward against the low end of my full year trading range and S&P cash provides 1.6x more risk relative to reward when compared against “fair market value.”

I remain cautious on the markets over the near- and intermediate-term.

That said, I am giving the current market advance (from the recent lows) a wider berth given the dominance of risk parity, volatility trending and passive strategies (ETFs) that tend to exaggerate short term market moves.

Continued Volatility Lies Ahead

We remain in a Bull Market for Volatility – if not in an absolute sense, certainly relative to recent history.

The roller coaster market, with no memory from day to day is likely in place for the balance of the year – ideal for traders but problematic for longer term investors.

I am a scale short-seller now as investor confidence will likely build over the near term in the face of some spectacular EPS reports – but substantive market headwinds (often delineated in my Diary) remain in place in a cycle that is beginning to exhibit late cycle characteristics (in inflation, growth, etc.).

Tread carefully and consider raising cash on strength.

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