Article Treasure Cove

Once again Doug Kass pens a Bearish take on the economy and markets. Once again, I must take exception to Kass’s assessment of the future. Where Kass and his brethren, such as Bill Gross, Mohamed El-Erian and David Rosenberg fail in their analysis, is in the idea of “this time it is different”. Every time I hear those five words, I know the opposite is true: “this time is the same as it ever was”.

Kass and the others contend that we will face “non-traditional headwinds” to the economy. This implies that most often the economy must deal with traditional headwinds, I guess. That premise is a fallacious idea from the beginning. No two economic crises are the same. Every event in my 50 plus year experience is different. And always, the economy recovers. Any so-called statistical “outliers”, or what are called by the Bears “black swans”, always mean-revert.

So too will it be this time. Housing prices which did dramatically diverge from long term price appreciation trends that roughly follow long term inflation, shot up in the early 2000′s. Then, as is normal for an overshoot, they have over-corrected to the downside. Now they will revert to the old pre-2000 trend line. Credit creation which was excessive in the past ten years will return to a path dictated in the early 1990s. The same is true for every economic series. All revert to a long term mean that is determined by human behavior and the governing economic system, not by short term policy mistakes and resultant excesses.

Kass’s (and El-Erian’s) assertion that many of the “headwinds” are non-traditional, is questionable in the first place. In his most recent post titled “Bearish Arguments Are Roaring in My Ears” Kass, as is his wont, gave readers ten such headwinds. I will challenge several of the points he makes, that are in fact, traditionally part of an economic recovery, not unusual as suggested by Kass:

1. That deep corporate cost cuts can’t be maintained to improve corporate bottom lines, and that top line revenue growth is required to continue profit growth; this is obvious and is a characteristic of every recovery, not just this one. To the degree that corporate managers have studied their history and have been much more aggressive and anticipatory in cost cutting in this cycle, it actually bodes very well for tremendous profit growth when revenue growth returns. Companies are very lean at this time and have very high operational leverage.
2. That cost cuts “pose an enduring threat to the labor force”; while this may be true, it is not new. This condition accompanies every business cycle since the Industrial Revolution. Productivity improvement is constant and recessions provide the cover for corporate managements to reduce labor made unnecessary by productivity improvements. The economy adjusts and new more meaningful jobs are created to replace mundane or dangerous jobs displaced by advances in technology.
3. That the consumer entered into this recession with credit badly damaged and with a need to save and invest to replace lost equity; this is also true, though again is true in every economic cycle. There is always a de-leveraging accompanying a recession. Over-leverage, either operational (too much new production capacity) or financial is most often the reason for the recession. The increased savings resulting from a natural defensive reaction to a recession will most likely end up in equity investments with interest rates currently near zero. So, a return to savings and investing is good for the equity markets and will be good for consumer markets with an eventual return of the wealth effect.
4. Kass’ fifth point was that Federal monetary efforts are “experimental”; this is simply not true. They have been used in the past and were mostly innovated in the Great Depression. What is somewhat different this time was the magnitude of the monetary policy; but such a response was needed due to the magnitude of the credit contraction;
5. In Kass’ eighth point, he declared that fiscal stimulus to compensate for the recession (unemployment benefits, for example) creates a negative multiplier effect; How So? That makes no sense at all; to the extent that money is put in the hands of a consumer, then that money will multiply as it always does; putting money to consumers would never cause less spending by others in the food chain, this is just common sense; it might be inflationary at some point if the Federal government runs a deficit to fund the transfer; but that is an entirely different set of problems and inflation normally accompanies too much monetary multiplication, not too little;
6. Kass declares that “Municipalities have historically provided economic stability during times of economic weakness “, but not this time; again I challenge this assertion; it makes no common sense; municipalities are always challenged by economic downturns; revenue (tax) sources of all types see contraction and expenses for social services always expand to cover economic hardship (housing services, etc); Orange County, CA and New York City both experienced near-death during economic crises (1994 coming off the Mexican economic collapse for OC and 1975 during the 1974-75 recession, to name two high-visibility incidents);
7. And to Kass’ last point regarding higher marginal tax rates and the deleterious effect on consumption, it is unclear to me that the recession has anything to do with the potential for higher tax rates; with a more Democratic, “big government” Congress and Presidency, higher national taxes would have a high probability regardless of the economic backdrop; and the current recession pushes that eventuality back in time, if anything;

So, once again Kass, who is an otherwise special and thoughtful, even poetic commentator on the economy and markets, twists data points to build a case to justify his own Bearish position, rather than allowing reality to dictate his strategy, as he did back In March when he called the market bottom. There is enough real evidence to build a case for a conservative or neutral market stance. On the other hand, it takes a lot of effort to trump up or distort facts to try to make the case for a Bearish market scenario going forward.

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Tags: Bearish