November 27, 2013

Doug Kass on why the markets can rally

While quantitative easing today might be driving asset prices to potentially unsustainable levels, without stimulating much additional activity, those levels are not that out of the ordinary.

Finally, unlike the exporting of derivatives by our major money center banks (in the last cycle) that nearly bankrupted the world's financial system in 2007-2009, there is none of that today.

November 25, 2013

Stocks are richer than most investors think

There is clearly a lot of momentum in the equity markets as proven last week by the Dow Jones soaring to an all-time high of 16,000 in one of its swiftest 1,000-point moves in nearly two decades.

Doug Kass, president of Seabreeze Partners Management Inc., in a recent Real Money article argues the current P/E multiple would be a lot higher if you applied a normalized profit margin on the revenues of S&P 500 companies.

Mr. Kass points out earnings are also inflated due to unsustainable low corporate tax rates. As politicians in Washington begin taking a hard look at the U.S. deficit, it is very likely that tax rates will trend higher, thereby taking a bite out of corporate profits.

Another factor that has contributed to record corporate profit margin growth is ultra-low interest rates. They have boosted corporate profits in the U.K. and the U.S. by 5% in 2012 alone, according to a new report from the McKinsey Global Institute.

More importantly, companies such as Tim Hortons Inc., Johnson Controls Inc. and Yahoo Inc. have been issuing billions of dollars of low-cost debt and using the proceeds to buy back their stocks. Companies can inflate earnings per share by reducing their share counts and either taking on more debt or using their excess cash rather than reinvesting it in their company.

More than 80% of S&P 500 companies are currently buying back shares, and they are doing it at twice the pace seen in the 1990s, according to a recent Goldman Sachs report. In total, buybacks are now up 40% on a trailing four-quarter basis and are expected to expand by an incremental 10% in 2014 given that cash balances are currently over US$1-trillion.

November 21, 2013

Markets can still go higher, not bubble yet

Doug Kass on Debt, Investor Sentiment and stock market:

While debt is cheap and plentiful to some, it is not universally so, as lending standards (especially mortgages and small-business loans) are relatively tight.

While investor sentiment is optimistic (and at multiyear highs), retail investors remain relatively noncommittal to stocks, and there is no new marginal buyer of equities (as was the case in the late 1990s). Nevertheless, the Investors Intelligence gauge of adviser sentiment (at a 55.2% bullish reading and only 15.6% bearish) is not only at the highest difference between the two in 2013 but at the most extreme reading since mid-April, a point in time when stocks experienced the largest correction of the current bull market that began in March 2009.

While some investors might be thinking that a new era lies ahead, they are in the minority.

Bottom line: While equity markets might be richly priced relative to fair market value, I would conclude that we are not currently in a stock market bubble yet.

November 19, 2013

The ten laws of bubbles

Doug Kass gives his take on the top 10 conditions on Financial Bubbles

1. Debt is cheap.

2. Debt is plentiful.

3. There is the egregious use of debt.

4. A new marginal (and sizeable) buyer of an asset class appears.

5. After a sustained advance in an asset class's price, the prior four factors lead to new-era thinking that cycles have been eradicated/eliminated and that a long boom in value lies ahead.

6. The distance of valuations from earnings is directly proportional to the degree of bubbliness.

7. The newer the valuation methodology in vogue the greater the degree of bubbliness.

8. Bad valuation methodologies drive out good valuation methodologies.

9. When everyone thinks central bankers, money managers, corporate managers, politicians or any other group are the smartest guys in the room, you are in a bubble.

10. Rapid growth of a new financial product that is not understood. (e.g., derivatives, what Warren Buffett termed "financial weapons of mass destruction").

November 4, 2013

Fed is confused and a toothless paper tiger

I describe the market's view of the Fed as a toothless paper tiger based on the fact that the federal funds rate at year-end 2015 is being discounted to 62 basis points vs. the Fed's forecast of 1%.

As I described yesterday in "Happy Halloween From the Fed," I consider Wednesday's FOMC statement as a bunch of wrong-footed and low-quality gibberish.

Clearly, the Fed is now in a bind. The dual mandate would suggest that current monetary policy would stay in place for a lengthy period of time (read: many years). The more the Fed's balance sheet expands, however, the higher the amount of losses to the Treasury down the road. In its extreme, this could pose a risk to the Fed's independence. This issue has been a talking point in academic and policy circles over the past two years -- even the International Monetary Fund cited this risk recently.

Let's review the confusing timeline of Fed tapering commentary in 2013:
On May 22, Humphrey Hawkins questioning Chairman Bernanke's "next few meetings" comment stopped the market's bull run, which had previously behaved as if the notion of tapering was so far out not to matter.
Bernanke's post-June 19 press conference led the markets to trade as though tapering were likely to begin in September. The S&P 500 lost 5% in four trading days, while the bond market suffered a brutal beating (as 10-year U.S. note yields rose from 2.05% to 2.95%).Then Bernanke blinked. Financial conditions tightened as mortgage rates climbed.

So, at the July 10 press conference after the NBER speech in Boston, the Chairman moved toward a very dovish stance, citing a weaker-than-forecast economy. No longer was the unemployment rate of 6.5% a trigger to policy -- there were conditions placed on the jobless rate. But, it seemed to markets that the message was that a September tapering was still on.

The Sept. 19 no-tapering meeting surprised the markets, with only Esther George dissenting.It is clear that the Fed is confused and the markets view our monetary authorities as a paper tiger.
In the extreme, the Fed appears to be almost paralyzed. In all likelihood, the economic data in the near term will be distorted and ambiguous. There is simply not enough clean data for a confused Fed to make policy changes at the December meeting. A January tapering is also unlikely, as it coincides with another debt ceiling negotiation, and this Fed doesn't seem to be in the mood to upset the markets.

November 3, 2013

Kass: Nix the VXX

I have received a number of inquiries from subscribers on whether iPath S&P 500 VIX Short-Term Futures ETN (VXX) should be purchased given the complacency that exists today.

My answer is no. I would rather be short SPDR S&P 500 ETF Trust (SPY) -- in fact, I currently am -- and what follows is my explanation. There is little question that the implied volatility of stocks is very low now, both on an absolute basis and relative to the last year. This reflects the consensus view that market risk is low and that the market has climbed consistently to new highs.

In recent periods, the implied volatility (VXX) has risen only when stocks have corrected meaningfully. Small pullbacks have had a limited impact on the VXX. In the last week and a half, the realized volatility has been 6% with implied at 12%. Seasonally, November-December tends to experience low realized volatility. The VXX is based on VIX futures, which embed a very high forward premium and possess a large negative carry. As an example, the VIX is 13.41 but January forward VIX is 16.85. So if the market is flattish between now and January, the negative roll yield is rotten. Additionally, the long VIX futures have a skew delta, so as the market rises toward higher strike prices, implied volatility falls. This means if you are long VXX, it is the equivalent of being short the stock market coupled with large negative carry.

Stay away from the product.