August 2, 2013

Seven reasons why the market is topping out: Doug Kass

Doug Kass has long been bearish on the market—and that has long been the exact wrong call. But now, Kass says the market's moment of truth is finally upon us.

"I've certainly been wrong," Kass admitted. "But being wrong doesn't keep me from warning investors."

And warn investors he did, for Kass sees this as a particularly treacherous time. "I think when the searchlights of the investor are the dimmest, when the economic and market threats are the greatest, and when market participants are the most comfortable in their inattentiveness and ignorance, the risks are surging—and that's precisely where we are now."

So what exactly is making Kass so concerned about the market right now? The president of Seabreeze Partners Management laid out his reasons on Tuesday's "Futures Now."

1. Stagnating GDP will weigh on revenue

Kass noted that "projections for second-quarter GDP—real GDP—are now under 1 percent." Indeed, Barclays cut its Q2 GDP growth forecast to 0.5 percent on Monday, and Goldman Sachs reduced its estimate from 1.3 percent to 1 percent.

Kass believes this stagnant rate of growth will be a major constraint on corporate revenue. "You've got to see a sharp acceleration in the second half for companies to have any top-line growth whatsoever," Kass said.

2. UPS lowers expectations

On Friday, UPS gave Kass one reason why this "sharp acceleration" is unlikely to come to pass. "I can't see it," Kass said, "with UPS cautioning about domestic economic growth."

UPS shares dropped by 6 percent on Friday after the company reduced earnings guidance. And one of the reasons the global shipping company gave for cutting guidance was "a slowing U.S. industrial economy." This is in line with Kass' thinking about what the rest of the year will bring.

3. Coca-Cola's weak shipments
On Tuesday, Coca-Cola gave Kass another reason to be bearish. In an earnings report that CEO Muhtar Kent said he is "not happy" with, Coca-Cola reported that soda volume in North America fell 4 percent.

That said, Kent pointed to factors that were more meteorological than economic: "We experience an extremely wet and cold second quarter," he said on Tuesday's earnings call, and "this weather clearly impacted our industry's volume growth."

4. Citigroup's North American worries
Kass also noted a third company sending off warning flares: Citigroup. Kass noted that on their earnings call, the company said that the "North American consumer looks especially weak in the second half."

Indeed, as Citigroup CFO John Gerspach discussed the company's second quarter results on Monday, he warned: "In North America consumer, the environment remains challenging, with a combination of spread compression, consumer deleveraging, and slowdown in mortgage refinancing activity expected to put pressure on revenues for the remainder of the year."

5. Refinancing slowdown
Another of Kass's concerns is one he shares with Citigroup. Due to a rise in interest rates that is expected to continue as the Federal Reserve rolls down its easing program, Kass also predicts a slowdown in mortgage refinancing.

"You have refinancings collapsing," Kass said. "That's an important source of household cash flow." The rise in rates, then, could end up further weakening the U.S. consumer for that reason.

6. The coming taper
On top of all of these concerns, Kass brings up what might be the market's biggest focus: "The Fed is on the doorstep of tapering, and interest rates are climbing."

Why is that so dangerous? "The global economic recovery lies on the foundation of easy monetary policy," Kass said. With no Fed easing undergirding the economy and the market, interest rates are expected to rise, making money more expensive to borrow and making stocks look worse in comparison to bonds.

7. The stronger dollar
Kass's final concern is tied to tapering. "The U.S. dollar's getting stronger, laying the groundwork for weakening exports," he said. As the Fed looks to exit the bond market, the dollar looks more attractive, because inflation is expected to slow as the Fed "prints" more dollars. This will be especially likely if other countries continue to embark on easing policies to stimulate their economies.

Kass notes that a stronger dollar hurts the export market. Indeed, when each dollar is worth more when compared to, say, the euro, it takes more euros to buy American products. This makes American products relatively more expensive for Europeans to buy, and thus puts pressure on exports.

So with all these risks, what's the market's next move? "I'm flat-out saying that the market is making a top here," Kass said.