Is the Irrational In Markets Now Being Rationalized?

Is the Irrational In Markets Now Being Rationalized?
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*     In a paperless and cloudy world, are investors and citizens as safe as the markets assume we are?In a flat, networked and interconnected world, is it even possible for America to be an "oasis of prosperity" and a driver or engine of global economic growth?

*     With the G-8's geopolitical coordination at an all-time low, how slow and inept will the reaction be if the wheels do come off?

-- Doug's Daily Diary, I'm Bearish in Word and Deed

Those three heady questions (above) continue to haunt me -- more often these days than even in the past.

And so does the observation that I have slowly watched the pith (in analysis) be eroded/abandoned as the post-election market rally has made ever more progress.

The trend, it is argued, is your friend.

In viewing the business media (and the talking heads that deliver their self-confident advice), it's almost as if everything has been reduced to looking at charts and/or espousing superficial sound bytes that have little consequence (and even less than unique insights). The latter is a condition I refer to as being three miles long but only inches deep!

The bears are worn out (or broke!) in defense of their view as the bulls dismiss their logic and meaning under the accusations of being non-opportunistic/theoretical, at best, or investment profit destructive, at worst.

I get the concept of, as Joplin sang, to "get it while you can" and that "the trend is your friend." Within reason, that is.

Importantly, with the exception of a handful of Perma Bears, I find no one that is even remotely threatened by a serious market drawdown -- despite the existence of such uncertainty on the political, geopolitical, monetary (and other policy issues -- see my questions above), economic and profit fronts.

Indeed over the last week, several previously cautious sell-side strategists acquiesced and materially ramped up their S&P targets by non-trivial amounts.

This, to me, could be end of cycle stuff that resembles prior periods of unjustified market optimism (in 2000 and 2007).

Plain and simple.

By my calculation (which I will offer up later in the week), the downside risk trumps the upside reward by a factor of three -- four to one over the balance of the year.

Does that mean there are no longs that are attractive? Of course not. I have some of them, hopefully, on my Best Ideas List (I have recently added to Allergan (AGN) , Campbell Soup (CPB) , Hartford Financial Services (HIG) and the initiation of a Twitter(TWTR) long).

But taking bold investment and trading "shots" without thoughtful analysis in an eight-year-old bull market is not likely the path in delivering superior investment returns in the months ahead. And I see it going on in nearly every corner of the investment world.

We will likely find out whether the fantastic market rip that we have experienced since early November is on fumes or has more to go.

I suspect you all know the path I think we are on.

Bottom Line

"WALL STREET ON TRUMP: EVERYTHING IS AWESOME! - POLITICO's Ben White and Mary Lee: "Seen from Wall Street, the Trump presidency is going perfectly. Travel ban troubles? Whatever. Russian revelations? Meh. Staffing woes? Who cares. Stocks continue to shrug it all off and rocket to new highs on the promise of big tax cuts, infrastructure spending and mass deregulation.

"But analysts now caution that Trumphoria in the stock market could soon crash into a harsh Washington reality. Before even getting to tax reform - where there is little agreement on the way forward - Republicans have to figure out how to repeal and replace Obamacare, confirm a Supreme Court justice and deal with Democrats eager to slam the brakes on anything and everything ...

"The result could be that a frothy stock market Trump derided as a "big fat bubble" before the election - but now takes credit for - suddenly plummets back to earth. 'The stock market is completely wrong,' said Douglass Kass of hedge fund Seabreeze Partners.

"'My view is that the fiscal path and regulatory reforms coming out of Washington ... are likely to provide a lesser and later contribution to economic and profit growth than the consensus expects. I don't think it should be friendly to the markets.'"

-- Politico, Morning Money

Throughout the last four decades I have learned that persistently higher stock prices results in a near-conditioning of investors into expecting more of the same -- rising markets bring with it rising expectations and vice versa.

Optimism in and of itself is not dangerous, but risks and the chances of disappointment expand as optimism multiplies. 

And it can be argued (or at least I try!) that expectations (especially of a policy-kind) are now at or near their highest level at any time in this bull market that started in the first week of March 2009.

At the core of my concerns is my belief in the growing probability that the president's initiatives will be less and later than consensus expectations, and that the optimistic economic and profit assumptions will be woefully off the mark.

High expectations currently incorporated in stock prices, may soon may be challenged by an increase in volatility as the Fed tightens, increased uncertainties and concerns spurred by the European elections and by a very high bar with regard to domestic economic and earnings growth estimates for 2017-2018.

Everything's awesome... but for how long?

Doug Kass is president of Seabreeze Partners Management Inc. 

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