My 'Fast Money' Recap

 | May 09, 2012 | 12:00 PM EDT
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This commentary originally appeared at 8:12 a.m. EDT on May 9 on Real Money Pro -- for access to all of legendary hedge fund manager Doug Kass's strategies and commentaries, click here.

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 I talked both bonds (sell) and stocks (buy) in last night's segment.

Let's go directly to the tape!

I continue to view the short bond trade as having a very favorable risk/reward yield. The herd is buying bonds. And, as we have learned from history (and certainly in 2008-2009), the herd's instincts can take a dive.

By contrast, I would buy (stocks) in May and go away.

My view is that the equity market is approaching a point at which it's getting far too negative on U.S. economic and corporate profit growth.

And the bond market, with a 1.85% 10-year yield, is also too convinced that U.S. growth will falter.

Risk/reward has shifted to an attractive area for the S&P 500 and to a most unattractive level for bonds. I have been raising my invested positions in stocks further into the last four days of market weakness, and I have increased my short bond trade exposure.

Good news is being ignored; bad news is being emphasized.

Monday's Jolts report is an example. March job openings reached their best level in four years. The most important feature to the report was how broad based the release was. Every private sector industry looked to expand employment, and the manufacturing sector was especially strong in job openings.

Also, the drop in crude oil prices and in gasoline prices over the last month is being ignored -- it's a tax cut to the consumer -- and so is the Ford (F) news that it plans to curtail planned factory shutdowns this summer.

I am looking for stability in Europe and for the flight-to-safety trade to abate. Historically, bond yields exceeded nominal GDP growth. Nominal GDP growth is the sum total of real GDP (running 2%-plus) and inflation (also running 2%-plus). So, today's 10-year U.S. note yields 1.85%, well under nominal GDP growth of around 4.5%.

Brian Kelly compared Japan to the U.S., arguing that bond yields can go much lower than most expect. While some of the seeds of weakness in the two countries are similar, I responded that the comparison between the two countries is not a valid one -- Our population is not aging, debt/GDP is better here vis-à-vis Japan, and we face a more vibrant economy.

The proximate cause for this week's equity weakness was the European weekend voting results, but one could make the case that Hollande's victory (which was predicted by Ladbrokes; he was 1:9 odds for the last two weeks) is a net positive as we will end up with a more activist ECB concentrating less on austerity and more on pro-growth fiscal policies.

As to Greece, who cares? As Miller Tabak's Peter Boockvar remarked today, Greek bondholders have already been body slammed -- their debt is trading at around 20% of face value. How many times is the market going to discount Greece's demise? Meanwhile, Greece is going to have a new election in June, and the odds favor a pro-troika result.

Steve Weiss argued that the economy is weaker, citing structural unemployment, moderating profit growth and poor earnings guidance.

Again, notwithstanding the structural disequilibrium in the jobs market (something I have written about over the past five years), I disagreed.

  • Economic growth: Most observers are more cautious regarding domestic growth today, even though the recovery's breadth is better -- employment has improved, and there is a nascent recovery in the residential real estate markets.
  • Profits: Corporate profit momentum has turned positive -- the first-quarter beat was by over 500 basis points.
  • Housing: The outlook for housing is markedly improved. Household formations are recovering from the depths of the recession, the NAHB index and buyer traffic are at five-year highs while inventories of unsold homes are at five-year lows.
  • Household health: Consumer deleveraging is advanced -- household debt/GDP is back to trend line levels.
  • Employment: Indicators are improved relative to a year ago. Claims are lower -- ISM employment components are consistent with monthly private payroll gains of about 200,000; take out 20,000 government job losses, and you come out with monthly jobs growth of approximately 175,000 to 180,0000.

Many, like Weiss and Melissa Lee are fearful of the similarities between May 2012 and May 2011 -- a year ago, the market began a wicked decline.

I said there are more dissimilarities than similarities.

I believe history rhymes, and instead of May 2012 rhyming with May 2011, a more reasonable parallel is with May 1987. The May 1987 bottom was followed with a near-20% rally in the summer of that year. Below is a chart that overlaps the two periods.

S&P 500 1987 vs. S&P 500 2012
Source: Nautilus Capital Research

I am under no illusion that the stock market is poised for a move straight up to the Promised Land -- rather I expect an irregular grind to higher levels. Given the technical damage and the ambiguous domestic economic release, we likely need confirmation of my view of a self-sustaining recovery in additional data points over the coming weeks.

I don't have an idea as to the short-term direction of the markets, but I do feel strongly, that those with a three- to six-month time horizon will be rewarded -- perhaps richly rewarded.

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