June 30, 2014

Doug Kass on James Bullard of the Fed

James Bullard, the St. Louis Fed president, does not vote and is usually middle of the road on the dove/hawk scale, but he is shifting into the hawk camp today. 

He thinks inflation "may" reach 2% by year-end (vs. year-end 2015 that the FOMC dots show). He thinks the unemployment rate will drop below 6% by year-end (FOMC dots estimate 2015). And, he sounds like Mark Carney of the Bank of England with this line: "[M]arkets don't appreciate how close Fed is to goals."

His conclusion from this is that he forecasts the first rate rise at the end of first-quarter 2015. 

Bottom line: In terms of markets and rate policy, we can discount Bullard, because he does not vote, and Fed Chair Janet Yellen and New York Fed President William Dudley still rule the dovish roost. But, the reality of the recent unemployment rate and inflation data points to a sooner rather than later meeting of the Fed's mandates, and certainly before the mid-2015 aggregate FOMC estimates, and certainly earlier than stock market expectations.

In the midst of the poor first-quarter 2014 GDP report and mediocre durable goods figure, there was a bright spot in the data today.

The Markit measure of services in the U.S. in June rose to 61.2 from 58.1 in May. The survey is only 5 years old and thus doesn't have much history, but today's number was the best since it began. The new business component was up, but backlogs fell. Employment rose to the highest level since September. Cost pressures were evident, as input prices rose to the most since October, but the prices charged fell to the lowest since March, thus creating a potential margin issue if sustained. Business expectations for the next 12 months did moderate month over month. 

Bottom line: This figure has limited history, and therefore the ISM services index should be the preferred gauge of business service sentiment. But at least today's number somewhat shifts the attention back to the fact that as bad as the first quarter was, the economy certainly improved in the second quarter (but off a much lower than expected base).

The degree of follow-through in the second half of the year remains to be seen. The bond market is certainly giving its opinion on today's data as the two-year/10-year spread is narrower by 6 basis points, to the lowest in a year. Part of this is a vote on growth, and maybe now some of it is a vote on inflation and how the Fed may respond.

via http://www.thestreet.com/story/12760009/1/bullard-a-hawk-at-the-fed-parsing-markit-data-best-of-kass.html

June 25, 2014

When this rally could end

I have been thinking that a stock market top was likely based on the growing evidence of a rising rate of inflation and a decelerating rate of domestic economic growth -- something the fixed-income markets have sensed throughout 2014 and the Fed, again, failed to anticipate.

Moreover, my bearish argument has centered on the recognition that QE is now having a moderating impact on U.S. economic activity. Indeed, one can argue that QE is now having an adverse impact by penalizing the savings class, potentially impregnating our economy with inflation and worsening economic equality (among other factors).

Even if the Fed's policy is moderately effective, the burden of stimulating growth continues to ring hollow in Washington, D.C., where fiscal policy is inert -- and will continue to be so, especially with the recent defeat of Congressman Cantor.

The disconnect between the real economy and stock prices remains conspicuous. But, for now the markets are singing "Everything's Coming Up Roses," endorsing the notion that price is truth and ignoring this potentially toxic cocktail, instead assigning a Goldilocks  scenario (not too hot, not too cold) to the investment backdrop.

I had been discussing the potential for a speculative stock market blow-off, thinking it was occurring two weeks ago.
"A bull market is a lot like sex. It feels best just before it ends."  - Warren Buffett 

The June 18 rally resembled a Sotheby's auction of Jeff Koons' artwork -- frenetic and furious. Similar to my market top call, Koons' art has recently sold well above estimates.

That said, Yellen et al. are risking central bank credibility by ignoring the very metrics (employment and inflation) that were supposed to determine central bank policy.

So while investors rejoiced last week, it is quite possible that they will begin to focus on the intermediate-term effects of a Fed that is losing its credibility.

This could occur as soon as this week's PCE inflation rate is released.

And by then the rally might be old news.

Article originally published on June 19, 2014 on http://www.thestreet.com/story/12752208/1/fed-losing-cred-bull-market-in-complacency-might-crack-best-of-kass.html

June 23, 2014

Whirlybird Janet has lived up to her name

On June 18, Whirlybird Janet (the successor to Helicopter Ben) lived up to her name, and in the process, she and the Fed are likely losing their credibility posthaste.
Janet Yellen
Not surprisingly, the FOMC statement was essentially consistent with previous comments.

    -The Fed dismissed signs of emerging inflation, citing that it was running below the committee's long-term objective (I suppose under the belief that food and energy is irrelevant to the Average Joe).
    -The Fed maintained the notion that it would keep the federal funds rate at current levels well after tapering ends.
    -2014 U.S. economic growth was brought down, owing to the inclement weather. The unemployment rate was taken down a few tenths of a percent (by year-end 2014).
    -Core PCE inflation was taken up a tad to between 1.5% and 1.6%.
    -The "dots" exhibited a higher expectation of GDP growth for 2015 and a bit lower for the long run rate.

The Fed did not lift inflation targets for 2014-2015.

Whirlybird Yellen failed to mention the pickup in inflation, which was made quite clear in a June 17 CPI release and abundantly clear to most consumers. While understandable and consistent with Yellen's dovish history (and why I nicknamed her Whirlybird), this is shortsighted, as the employment and inflation data fail to warrant a more dovish statement.

The Fed's errant economic forecasts have been well-documented.

Since 2009, the Fed's economic projections have substantially overstated domestic economic activity, failing to recognize the strength of the structural headwinds and the residual impact of the 2007-2009 Great Decession. (Note: Before 2009, the Fed's projections were spotty as well.)

Nevertheless (and surprising to me), investors and traders still take the Fed's forecasts as gospel. 

via theStreet http://www.thestreet.com/story/12752208/1/fed-losing-cred-bull-market-in-complacency-might-crack-best-of-kass.html

June 18, 2014

Doug Kass says its not too late to reduce US Stock market holdings

Doug Kass summarizes his views as the following

-    Fear has been driven from Wall Street and there is no concern for downside risk.

-    Global economic growth is falling short of earlier forecasts, while a number of regions are flirting with deflation.

-    While the shoulders of economic growth have relied on central banker policy, in the absence of regulatory and fiscal reform, QE's impact is now materially moderating.

-    S&P profits are estimated to have risen by only about 10% in 2013-14, against a 38% rise in the S&P Index. (The difference is the animal spirits' impact on rising multiples, something everyone now accepts, but none anticipated 18 months ago).

-    Though fundamentals remain soft, (with sales and profit growth muted), bulls are self confident in view as share prices propel ever higher.

-    Bullish sentiment (measured by Investors Intelligence bull/bear spreads, etc) is at a historical extreme.

-    Shorts are and out-of-favor, endangered (and ridiculed) species.

-    There is less to valuations than meets the eye.

I would strongly consider reducing exposure to the U.S. stock market. I swear its not too late!

via http://www.thestreet.com/story/12742083/1/kass-turn-turn-turn.html

June 16, 2014

Five reasons to be cautious of market

1.   We are in a bull market in complacency. Complacency means, "self-satisfaction, especially when accompanied by unawareness of actual dangers or deficiencies." Bulls have rarely been more self confident in view (just watch the talking heads in the business media). But there are numerous dangers to the bull market in stocks that are being ignored by many, including subpar economic growth, which is still (five years after the Great Recession) dependent on exaggerated and extreme implementation of monetary policy, a growing schism between haves and have-nots (after the failure of QE), weak top-line sales growth, vulnerability to corporate profits (and profit margins), a consumer sector that is spent up, not pent up, etc.

2.    Arguably, valuations ARE stretched. I would repeat for emphasis that while price/earnings ratios (against stated or nominal profits) are only slightly above the historic average, normalized profits are well above the historic average, as profit margins are now exposed to a reversal of the factors (interest rates will rise, productivity will fall and reversals of bank industry loan loss provisions will moderate) that contributed to the 70%-above six-decade average and at a near-60-year high. Looking at nominal or stated profits (projected at S&P $117-120/share) rather than normalized earnings (to account for degradation in profit margins) could prove to be a fool's errand, just like the mistake that was made back at the Generational Bottom (when trailing earnings of only $45/share understated normalized corporate profitability). At that time in 2009, investors were as reluctant to buy as they are emboldened to buy in 2014.

3.    There are bubblicious pockets of extreme overvaluation. Above all, there is most definitely a bubble in the belief that central bankers can guide the economy higher and into a self-sustaining trajectory of growth absent fiscal and regulatory reform. (It's been five years and we are not yet there.) Importantly, bubbles are not the mandatory starting point to corrections, as stocks often fall from excessive valuation rather than bubbles.

4.   While equities are less frothy than fixed income. I don't feel stocks are inexpensive or compelling buys at the margin. I don't buy the either/or argument, as cash is an asset class. At numerous times in history, not losing money (and being in cash) is a reasonable alternative to being in risk assets.
5.   The domestic economy is unlikely to kick in and gain escape velocity in 2014's second half. Though it has maintained its second-half optimism recently, I expect that the Federal Reserve will end up lowering its official economic forecast. The recovery and wealth effect has been lopsided, favoring the wealthy. It is not broad based. This is clear in the U.S. housing market's pause since last summer. The consumer (the average Joe suffering from stagnating wages and higher costs of the necessities of life) remains the Achilles heel of U.S. economic growth. And the growing savings class is an important constituency that will continue to be penalized by zero-interest-rate policy. Most economists have predicted escape velocity for the U.S. economy since 2011. They have been wrong footed and might continue to be.

June 2, 2014

Lack of fear in market

Throughout the last 12 months the market has risen against a backdrop of very low volume, leading the way for high-frequency traders and others whom have adopted price-momentum and trend-following portfolio strategies to have an exaggerated impact on stock prices.

As mentioned previously, stock prices have risen, investors have grown increasingly complacent, and many strategists and commentators have said that market participants should be ignoring the rotten volumes. 

To be sure, low volume, complacency and even technical divergences are not reliable timing tools.

Nevertheless, the rise to new all-time highs is potentially troubling when these issues are factored in with some continuing fundamental concerns -- for instance, disappointing global economic and corporate profit (and margin) growth, corporate and consumer dependency on low interest rates, the failure of QE to generate a self-sustaining expansion and so forth -- the result of which is a detachment and a blurring in the demarcation line between markets' progress and economic and profit fantasy.

We should be vigilant and aware that the U.S. stock market's risk/reward ratio is eroding with each passing rise in the S&P 500. (How much so we will only know in hindsight.)

Most investors and traders who share my concerns might begin to consider taking down portfolios to below-average exposure to the U.S. stock market now and to continue to do so into any further ramp in stock prices. More aggressive investors might ponder shorting opportunities in the days and weeks ahead. 

In summary, while it is impossible to predict when, Minsky might soon have his moment, as one of the only things we need to fear today is the lack of fear itself. 

Article originally published on http://www.thestreet.com/story/12724898/1/kass-prepare-for-a-minsky-moment.html