April 11, 2016

Doug Kass adding more net-short positions

It looks from my perch like global equity markets have sharply decoupled from both fundamentals and the real economy. What's even more surprising to me is the growing acceptance of that divergence, with financial-asset prices rising even as economic headwinds multiply.

The stock market's major indices have advanced rapidly from their February lows despite slightly less than 1% average U.S. real gross-domestic-product growth rates over the past six months, coupled with four straight quarters of negative S&P 500 earnings comparisons.

Meanwhile, the three factors that have contributed to profit-margin growth -- low interest rates, low effective corporate-tax rates and nonexistent wage gains --seem destined to bottom out and reverse.

Many investors see the U.S. dollar's drop as an important factor in emboldening the bulls (or at least as a partial explanation). But it's important to appreciate that the dollar hit a 14-year high not that long ago, so we have to put the greenback's recent weakness into perspective.

Other countries economies are getting worse too

The Nikkei 225's modest rise overnight in Japan snapped seven straight sessions of declines, which had been the index's longest losing streak since November 2012 [Abe's "Abenomics" started].

The recent declines have been due to the apparent failure of Japan's easy monetary policies. As I feared, negative interest rates are strangling the Asian nation's aging population. Consumers are hoarding cash and personal consumption is plummeting (a motion picture that may be coming soon to a theater near you).

Meanwhile, Europe's Euro STOXX Bank Index has declined for the 15th session in the past 17 and is 18% below its March high -- a fact ignored by many U.S. investors.

Other Factors

There are no doubt other factors at work that are providing catalysts to the U.S. stock market's recent rally.

For example, gamma trading, risk parity and other quant strategies are probably all goosing and chasing stock prices. That's in the "DNA" of those strategies and their accompanying algorithms.

It might also help that many hedge funds have suffered mightily from adverse stock selection. so they've "de-risked" and have found themselves forced back onto the long side.

The Bottom Line

We're currently in "Bizarro World" in many ways, with the irrational increasingly being rationalized on Wall Street.

Yesterday's failed merger between Pfizer (PFE) and Allergan (AGN) is but one example. In true Bizarro fashion, Allergan's CEO went on business TV yesterday to say that the U.S. Treasury's anti-merger decision was "un-American." But arguably, the only un-American thing about the deal was Allergan's exploitation of a U.S. tax loophole by putting its corporate headquarters in the tax haven of Ireland.

Meanwhile, the market's technical situation remains unclear.

I think it's also worth noting that the ratio of bears in this week's AAII Investor Sentiment Survey has fallen to its lowest level -- 21.5% -- since early December after peaking at 48.7% amid February's market bottom. Bulls have risen to 32.2% (up five percentage points) as renewed investor optimism has accompanied higher stock prices.

The "bull market in complacency" is obviously alive and well, returning with gusto over the last 1-1/2 months. But market optimism in the face of flailing fundamentals is something that Wall Street more typically sees at or near a market top than a market bottom.

That's why I've used stocks' recent strength as an opportunity to add to my short book, and why I'm now at my maximum net-short exposure. I'm sticking to my view that the market made an important, broad top in May 2015.

At best, I see an unattractive risk-vs.-reward ratio from here, in which downside risk substantially exceeds upside opportunities.

And at worst, I see a potential repeat of the 2007-09 financial crisis, although the players (public sector vs. private sector) will have changed.

It might appear that the strategy of chasing stocks isn't so wacky, as The Madness of Crowds has returned. But to me, the wacky thing is the market's advance itself -- which seems to have the weakest of foundations.

The bottom line is that I see stocks' recent gains as nothing more than a bear-market rally. And I believe that many who worship at The Church of What's Happening Now might have to find religion elsewhere over the balance of 2016.

via realclearmarkets