Doug Kass: Following Market Abundance, Seven Months of 'Famine' Lie Ahead

While the wheels are coming off — in so many directions — anything can happen these days (witness Thursday's juvenile and angry Musk/Trump exchange).

Never in my investing career has there been so many possible social, political, geopolitical, economic, interest rates and fiscal policy outcomes (many of which are adverse). That is why I don't understand the uber confidence expressed by the Perma Bull cabal (including Fundstrat's Tom Lee) and manifested in a near vertical move higher for equities over the last two months. It is also the reason why I have traded very actively, reduced my long holdings (purchased near the market lows) and have not bought for the purpose of holding in recent weeks:

On Thursday, Americans were exposed to unvarnished self interest, the continued loss of conventions and general lack of ethics and morals. Right in front of us it is obvious that political positions of influence can easily be bought — sold by both parties (and that certainly includes the Presidency). To this observer, few politicians are even pretending that they care about the American people.

Our government's tangled dependency on an unstable Elon Musk (SpaceX et al) has also been underscored (something I have written about for years). And so has Musk's dependency on President Trump and the U.S. been highlighted.

Finally, consider what the world outside of the U.S. thinks of us these days.

The Musk/Trump 'War' Is Much Like the Tariff 'War.' It Will Be Resolved In Time

I am not even sure where the performance ends and reality begins. In the end (probably sooner than later) — just like the president's opening salvos of ridiculously high tariff proposals — the two actors will likely have a detente (and kiss and make up) because the downside is certain for both of them as no one will win. When that make-up happens no one knows. It could happen today, next week or next month but the parties "interests" are now so enmeshed, that Musk and Trump recognize where their bread is buttered.

As darkly humorous this all is, the authoritarian nature (and the threats made) by the current administration is beyond the pale. And that Republican leadership doesn't speak the truth to presidential power and that the Democratic leaders don't even seem to exist — make the situation rather sickening and confirms my recently written "Rethinking of American Exceptionalism:"

* Political and geopolitical polarization and competition will probably translate into less political centrism and a reduced concern for deficits — creating structural uncertainties, limited fiscal discipline and imprudence around the globe ... and for the possibility of bond markets to "disanchor."

* The cracks in the foundation of the bull market are multiple and are deepening, but they are being ignored (as market structure changes have led to price momentum (FOMO) being favored over value and common sense).

* With the S&P 500 Index at 5965, the downside risk dwarfs the upside reward for equities — in a ratio of about 3-1 (negative).

* Valuations and (consensus) expectations for economic and corporate profit growth are all inflated.

* Being dismissed are JPMorgan JPM CEO Jamie Dimon's dour comments on complacency and his view that the corporate credit market is "ridiculously over-stretched" (hat tip Rosie).

* Look for the soft data (see yesterday's weak ISM and climb in jobless claims) to move into (and weaken) the hard data led by a slowing housing market likely to provide ample near-term evidence of the exposure and vulnerability of the middle class.

* Below trend-line economic growth with sticky inflation lie ahead ("slugflation") — uncomfortable for a Federal Reserve which has to make increasingly more difficult decisions.

With a forward P/E of 22x, equities remain overvalued and, after covering my Index shorts Thursday, I plan to reshort any rally.

With so many possible adverse outcomes, my baseline expectation is for (at least) seven lean months ahead and estimate downside risk to be roughly 3x the upside reward:

"In the Bible, 'lean years' refer to a period of famine that follows a time of abundance, particularly in the story of Joseph in Genesis 41. The prophecy, revealed through dreams to Pharaoh, foretold seven years of great plenty in Egypt, followed by seven years of severe famine. Joseph, interpreting the dream, advised Pharaoh to prepare for the lean years by storing grain during the period of abundance. This preparation allowed Egypt to survive the famine while other surrounding lands suffered greatly."

This commentary was orginally posted in Doug's Daily Diary on TheStreet Pro.

At the time of publication, Kass had no positions in any securities mentioned.