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Kass: Nowhere To Run, Nowhere To Hide?

Written by Doug Kass | Dec 21, 2018

“Nowhere to run, baby, nowhere to hide
Got nowhere to run to, baby, nowhere to hide
It’s not love I’m running from
It’s the heartbreak I know will come
Cause I know you’re no good for me
But you’ve become a part of me
Everywhere I go, your face I see
Every step I take you take with me…” – Martha Reeves and the Vandellas, Nowhere to Run

For the past year I have concluded that the market was vulnerable to a number of factors and was likely making an important top and likely setting up for a Bear Market:

  • Global economic growth was becoming more ambiguous and the fragility of worldwide growth would be shortly exposed
  • An avalanche of debt would serve as a governor to growth
  • Corporate profit expectations for 2018-20 were too elevated
  • The pivot to monetary restraint by the Federal Reserve (taking the punch bowl away) would be market unfriendly
  • With less liquidity would come a new regime of volatility
  • The risks of fiscal and monetary policy mistakes were growing
  • The behavior of the President and hastily crafted policy (e.g. the U.S. retreat from Syria) would make economic uncertainty and market volatility great again (#muvga)
  • The reduction in the corporate tax rate has failed to deliver the growth expected to reduce the burgeoning deficit – the benefit has trickled up and not down
  • Market structure represented a potential market threat that was being underestimated
  • Investors, participating in The Bull Market of Complacency, were ignoring the risks of a large market drawdown

I concluded that the notion of T.I.N.A (“there is no alternative) was no longer applicable and that rising short term interest rates made the compelling case for C.I.T.A. (“cash is the alternative”):

Chart Courtesy of Charlie Bilello of Pension Partners

Out of 15 major asset classes ranging from stocks to bonds to REITs to Gold and Commodities, only one is higher in 2018: Cash.

After the markets responded quite vigorously to the corporate tax reduction and cash repatriation bills in January, markets swiftly moved higher – making a top near month end. Consolidation and a multi-month period of choppiness followed but the markets made a new high by mid-September at about 2920.

The toxic cocktail of the above factors have contributed to a more than 400 handle drop (-13%) in the S&P Index to 2500 currently – below my (short term) expected trading range of 2550-2700.

Back in early July I presented this suite of projections for the S&P Index – which proved reasonably prescient, and to the penny we have just hit my six month projection of S&P 2500 (!):

By the Numbers

As SPYDERS moved towards $273 yesterday afternoon — on a full day spike in the S&P Index of over 20 handles — I moved back to market neutral.

Should the S&P Index climb back to 2,750-2,750 (my very short term prognostication), I will move back again to a net short exposure, as downside risk expands over upside reward.

My gross and net exposures remain light in a background of uncertainty (e.g., current trade battle with China) and in the new regime of volatility. Quite frankly, I am playing things “tight” in light of these factors — and in consideration that I have had a very good year thus far.

Again, my expectations below should be viewed not with precision, but rather as a guideline to overall strategy:

Very Short Term (in the next five trading days)

–Higher, but not materially so. 2,750-2,775 seems a reasonable guesstimate. 

–I plan to scale into a net short position on strength, but I will give the market a wider berth today and into the first few days of the second half (inflows expected). 

Short Term (in the next two months)

–Lower, but not materially so. 

–I expect a series of tests of the S&P level 2,675-2,710. 

Intermediate Term (in the next six months)

–Lower, a break towards “fair market value” of about 2,500 is my expectation. 

More Lessons Learned

When we ask for advice we are looking for an accomplice.”– Saul Bellow

The investment mosaic is complex and Mr. Market is often unpredictable.

There is no quick answer or special sauce to capture the holy grail of investment results – it takes hard work, common sense and the ability to navigate the noise.

The common thread of these naked swimmers are self confidence, smugness and the failure to memorialize their investment returns (because the typically are so inconsistent and dreadful).

They are bad and deceptive actors who are in denial to themselves and are artful and accountable dodgers to the investing masses.

“In my next life I want to live my life backwards.– Woody Allen

Take Woody Allen’s advice (above) – be forewarned and learn from history as common sense is not so common as:

“A nickel ain’t worth a dime anymore.”– Yogi Berra

– Kass Diary, Who’s Swimming Naked?

I have spent a lot of time over the last few months exposing the bad actors who, we learned, were swimming naked this year; as the market’s tide went out.

I did so, not because of any hatred but because I saw this also in 2008-09 and we should finally be learning from history so that we don’t call on those same resources in the futures.

Where Do We Go From Here?

“I’ll just conclude by saying most of the issues we are dealing with today are induced by bad political choices.– Fred Smith, CEO Of FedExpress (conference call)

Over the last year I have consistently written that “fair market value” (based on a multi-factor analysis) for the S&P Index was between 2400-2500 – well below the expectations of every major Wall Street strategist. I posited that 2018 would be the first year (in many) in which the revaluation of price earnings ratios would be headed lower. (Multiples are down by nearly 20% this year).

The major indices have had the worst month of December since the Great Depression – declining by about -9%. Though many pin the loss (especially yesterday’s) on the Federal Reserve’s actions and communications, the recent market drawdown is a function of the reality of the headwinds I listed at the beginning of this morning’s missive (that most have dismissed).

We are now at 2500 (down from 2920 three months ago) – which means the market is at the upper end of being fairly valued for the first time all year. It also means that an expanding list of stocks are now attractive if my recession expectations prove unfounded.

Expanding problems facing the White House and policy blunders (underestimated by investors – see FedEx quote above), reduced domestic economic expectations and a continuation of Fed tightening (and balance sheet drawdowns) have contributed to the latest market swoon. That drawdown has occurred in a backdrop of rising fear and some extreme sentiment readings – abetted by a changing market structure in which passive products and strategies “buy high and sell low.”

As posited this week I believe we are now going to have a playable year end rally from here but as we move into the New Year things get more problematic.

In my Surprise List for 2019, I wrote:

Surprise #3 Stocks Sink

“Though the third year of a Presidential cycle is usually bullish – it’s different this time.

Trump confusing brains with a bull market can’t fathom the emerging Bear Market. At first he blames it on Steve Mnuchin, his Secretary of Treasury (who leaves the Administration in the middle of the year). Then he blames a lower stock market on the mid-term election which turned the House. Then he blames the market correction on the Chinese.

The S&P Index hits a yearly low of 2200 in the first half of the year as the market worries about slowing economic and profit growth and a burgeoning deficit/monetization. The announcement of QE4 results in a year end rally in December, 2019. In a continued regime of volatility (and in a market dominated by ETFs and machines/algos), daily swings of 1%-3% become more commonplace. Investor sentiment slumps as redemptions from exchange traded funds grow to record levels. The absence of correlation between ETFs and the underlying component investments causes regulatory concerns throughout the year.

Congress holds hearings on the changing market structure and the weak foundation those changes delivered during the year.

Short sellers provide the best returns in the hedge fund space as the S&P Index records a second consecutive yearly loss (which is much deeper than in 2018).

As the Fed cuts interest rates the US dollar falls and emerging markets outperform the US in 2019. The ten year Treasury note yield falls to 2.25%.

I, like many, are concerned about corporate credit (See Surprise #8) and though credit is not unscathed, it is equities that bear the brunt of the Bear since they are below credit in the company capitalization structure.

Bottom line, after a steep drop in the first six months of the year, the markets rise off of the lows late in the year in response to this shifting political scene (the decline of Trump) and a reversal to a more expansive Fed policy – ending the year with a -10% loss.”

Bottom Line

* For now, think like a trader and not an investor”

The illusion of positive possibilities is fading quickly in a market hampered by political turmoil and strapped with untenable debt loads.

The key to delivering superior investment performance in 2018 was not a buy and hold strategy. Rather, it was opportunistic and unemotional trading and for the foreseeable future this will likely be the case.

While I believe we are likely to rally into year end, the near term upside to that rally has been markedly reduced (though I still believe we can reach to at least 2600 or so on the S&P Index by year end, a gain of 100 handles or more) — the likelihood of a recession and Bear Market in 2019 has increased.

Good morning Vietnam!


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Doug Kass

Doug Kass, since 2004 Doug Kass has served as President of Seabreeze Partners Management, Inc. He runs a hedge fund and individual managed accounts, co-authored “Citibank: The Ralph Nader Report” with Ralph Nader and the Center for the Study of Responsive Law in the 1970s and wrote "Doug Kass: A Life on the Street" two years ago (John Wiley). Since 2003 Mr. Kass served as a guest host on CNBC's "Squawk Box" and has guest hosted Bloomberg's "Market Surveillance" for the last five years. Along with Jim Cramer, Doug is the principal contributor to Real Money Pro.

2018/12/21
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