Doug Kass: Here Are My Surprises To Watch For In 2011

1. The improving momentum of domestic growth at the end of 2010 continues into the first half of 2011 but proves ephemeral by the summer.
2. That improving momentum turns out to be nothing more than a brief respite and "recession fatigue," as reality and a new normal sets in.
3. Americans remain in a foul mood, as the jobs market fails to improve despite the recent downtick in claims.
4. Over there, multiple country austerity programs move Europe back into recession by year-end 2011. (Share prices of many large multinational industrials falter in the year's second half.)
5. China continues to tighten, but inflation remains persistent, economic growth disappoints (see surprise No. 15), and it's stock market weakens further.
6. Political gridlock and inertia in tackling the deficit incite the bond vigilantes. The yield on the 10-year U.S. note rises above 4.50% by the spring (see surprise No. 2).
7. Trust continues to be lost, as the uncertainty brought by changes in the administration (see surprise No. 7) and the emergence of a third political party (see surprise No. 8) adversely impacts consumer and corporate confidence.
8. Housing fades under the pressure of higher mortgage rates and the supply of shadow inventory coming onto the market in an avalanche of foreclosures. (A housing czar is named to implement a Marshall Plan for housing.)
9. An across-the-board spike in commodities pressures corporate profit margins and real disposable incomes (see surprise No. 3).
10. Price controls are briefly considered (and then rejected) by the Obama Administration as oil soars to over $125/barrel.

Doug Kass’ 2010 Predictions

1. There is a glaring upside to first-quarter 2010 corporate profits (up 100% year over year) and first-quarter 2010 GDP (up 4.5%). It grows clear that, owing to continued draconian cost cuts, coupled with a series of positive economic releases and a long list of company profit guidance increases in mid to late January and early February, there is a very large upside to first-quarter GDP (up 4.5%) and, even more important, to S&P profit growth (which doubles!). The upside on both counts is in sharp contrast to more muted growth expectations. While corporate managers, economists and strategists raise earnings per share, full-year growth and S&P target estimates, surprisingly, the U.S. equity market fails to respond positively to the much better growth dynamic, and the S&P 500 remains tightly range-bound (between 1,050 and 1,150) into spring 2010.

2. Housing and jobs fail to revive. An outsized first-quarter 2010 GDP (up 4.5.%) print is achieved despite a still moribund housing market and without any meaningful improvement in the labor market (excluding the increase in census workers) as corporations continue to cut costs and show little commitment to adding permanent employees.

3. The U.S. dollar explodes higher. After dropping by over 40% from 2001 to 2008, the U.S. dollar continued to spiral lower in the last nine months of 2009. Our currency's recent strength will persist, however, surprising most market participants by continuing to rally into first quarter 2010. In fact, the U.S. dollar will be the strongest major world currency during the first three or four months of the new year.

4. The price of gold topples. Gold's price plummets to $900 an ounce by the beginning of second quarter 2010. Unhedged, publicly held gold companies report large losses, and the gold sector lies at the bottom of all major sector performers. Hedge fund manager John Paulson abandons his plan to bring a new dedicated gold hedge fund to market.

5. Central banks tighten earlier than expected. China, facing reported inflation approaching 5%, tightens monetary and fiscal policy in March, a month ahead of a Fed tightening of 50 basis points, which, with the benefit of hindsight, is a policy mistake.

6. A Middle East peace is upended due to an attack by Israel on Iran. Israel attacks Iran's nuclear facilities before midyear. An already comatose U.S. consumer falls back on its heels, retail spending plummets, and the personal savings rate approaches 10%. The first-quarter spike in domestic growth is short-lived as GDP abruptly stalls.

7. Stocks drop by 10% in the first half of next year. In the face of renewed geopolitical tensions and reduced worldwide growth expectations, stocks drop as the threat of an economic double-dip grows. Surprisingly, though, the drop in the major indices is contained, and the U.S. stock market retreats by less than 10% from year-end 2009 levels.

8. Goldman Sachs goes private. Goldman Sachs stock drops back to $125 to $130 a share, within $15 of the warrant exercise price that Warren Buffett received in Berkshire Hathaway's (BRKA) late 2008 investment in Goldman Sachs. Sick of the unrelenting compensation outcry, government jawboning and associated populist pressures, Warren Buffett teams up with Goldman Sachs to take the investment firm private. The deal is completed by year-end.

9. Second-half 2010 GDP growth turns flat. The Goldman Sachs transaction stabilizes the markets, which are stunned by an extended Mideast conflict that continues throughout the summer and into the early fall. While a diplomatic initiative led by the U.S. serves to calm Mideast tensions, flat second-half U.S. GDP growth and a still high 9.5% to 10.0% unemployment rate caps the U.S. stock market's upside and leads to a very dull second half, during which share prices have virtually flatlined (with surprisingly limited rallies and corrections throughout the entire six-month period). For the full year, the S&P 500 exhibits a 10% decline vs. the general consensus of leading strategists for about a 10% rise in the major indices.

10. Rate-sensitive stocks outperform; metals underperform. Utilities are the best performing sector in the U.S. stock market in 2010; gold stocks are the worst performing group, with consumer discretionary coming in as a close second.

11. Treasury yields fall. The yield of the 10-year U.S. note drops from 4% at the end of the first quarter to under 3% by the summer and ends the year at approximately the same level (3%). Despite the current consensus that higher inflation and interest rates will weigh on the fixed-income markets, bonds surprisingly outperform stocks in 2010. A plethora of specialized domestic and non-U.S. fixed-income exchange-traded funds are introduced throughout the year, setting the stage for a vast speculative top in bond prices, but that is a late 2011 issue.

12. Warren Buffett steps down. Warren Buffett announces that he is handing over the investment reins to a Berkshire outsider and that he plans to also announce his in-house successor as chief operating officer by Berkshire Hathaway annual meeting in 2011.

13. Insider trading charges expand. The SEC alleges, in a broad-ranging sting, the existence of extensive exchange of information that goes well beyond Galleon's Silicon Valley executive connections. Several well-known long-only mutual funds are implicated in the sting, which reveals that they have consistently received privileged information from some of the largest public companies over the past decade.

14. The SEC launches an assault on mutual fund expenses. The SEC restricts 12b-1 mutual fund fees. In response to the proposal, asset management stocks crater.

15. The SEC restricts short-selling. The SEC announces major short-selling bans after stocks sag in the second quarter.

16. More hedge fund tumult emerges. Two of the most successful hedge fund managers extant announce their retirement and fund closures. One exits based on performance problems, the other based on legal problems.

17. Pandit is out and Cohen is in at Citigroup (C). Citigroup's Vikram Pandit is replaced by former Shearson Lehman Brothers Chairman Peter Cohen. Cohen replaces a number of senior Citigroup executives with Ramius Partners colleagues. Sandy Weill rejoins Citigroup as a senior consultant.

18. A weakened Republican party is in disarray. Sarah Palin announces that she has separated from her husband, leaving the Republican party firmly in the hands of former Massachusetts Governor Mitt Romney. An improving economy in early 2010 elevates President Obama's popularity back to pre-inauguration levels, and, despite the market's second-quarter decline, the country comes together after the Middle East conflict, producing a tidal wave of populism that moves ever more dramatically in legislation and spirit. With the Democratic tsunami (part deux) revived, the party wins November midterm elections by a landslide.

19. Tiger Woods makes a comeback. Tiger Woods and his wife reconcile in early 2010, and he returns earlier than expected to the PGA Tour. After announcing that his wife is pregnant with their third child, both the PGA Tour's and Tiger Woods' popularity rise to record levels, and the golfer signs a series of new commercial contracts that insure him a record $150 million of endorsement income in 2011.

20. The New York Yankees are sold to a Jack Welch-led investor group. The Steinbrenner family decides, for estate purposes, to sell the New York Yankees to a group headed by former General Electric (GE) Chairman Jack Welch.

Doug Kass Calls The Bottom at S&P 666

Doug Kass called a market bottom on March 2. He says events now confirm that and his watch list of twelve economic indicators shows things are improving.

Kass called the market crash early, shorted Warren Buffett’s Berkshire Hathaway successfully when many thought doing so was insane, and in the years I’ve been reading him, seems plenty savvy.
He says the current mood of pessimism in the markets is astoundingly gloomy and  unwarranted. I would agree, and would expand that to include society at large. Some commentators appear to be trying to outdo each other with predictions of how dire things will become and how doomed we are.

On Feb. 17, he presented a watch list of conditions that, if in an improving trend, would likely indicate that a sustainable up move is possible for equities. 

He then reviewed this checklist (and added one more factor) to determine the market's standing. 

Bank balance sheets must be recapitalized. Yesterday a comprehensive bank rescue package was introduced. It is obviously too early to consider its full impact, but the details of the program suggest to this observer that it will likely be effective in clearing toxic bank assets. (We grade the package a B+, up from a D+ only two weeks ago.) 

Bank lending must be restored. While bank lending standards remain tight, my view is that yesterday's announcement of ring-fencing toxic bank assets will almost unquestionably succeed in unclogging the transmission of credit. (Grade B, up from a C previously.) 

Financial stocks' performance must improve. Financial stocks have finally awakened from the dead, and the recent outsized move to the upside could foreshadow continued market strength. Historically strong relative performance in the shares of asset managers -- such as Franklin Resources (BEN Quote - Cramer on BEN - Stock Picks), T. Rowe Price (TROW Quote - Cramer on TROW - Stock Picks) and AllianceBernstein (AB Quote - Cramer on AB - Stock Picks) -- presage a better equity market, and Monday's strong group action was conspicuous in its outperformance. (Grade B+, up from a D.) 

Commodity prices must rise as a confirmation of worldwide economic growth. Beginning two weeks ago, commodities' prices began to strengthen, and the Fed's message last week accelerated that trend. Gold, copper (at the highest level since November) and crude oil (over $54 a barrel) continued to rise yesterday, reflecting a combination of continuing inflationary and currency debasement fears coupled with the possibility that worldwide economic growth might stabilize sooner than later. Finally, the TIPS market is forecasting some higher inflation, and a little inflation is better than a lot of deflation. (Grade B, up from a C+.) 

Credit spreads and credit availability must improve. Spreads remain worrisome and the transmission of credit remains poor, but the economy should gain traction as public policy is implemented, money is made more available and lending terms are liberalized. (Grade D, flat from two weeks ago.) 

We need evidence of a bottom in the economy, housing markets and housing prices. The retail industry has exhibited evidence of sequential improvement in the January through March period. Other economic signs are somewhat more ambiguous but, nevertheless, are showing some life. Months of inventory of unsold homes are declining and so are mortgage rates, but home prices have yet to stabilize despite an improvement in the affordability indices and a better relationship between home ownership and rental costs. Nevertheless, yesterday's strong existing homes sales release raises the specter of a better spring selling season than most anticipate. I contend that housing could surprise to the upside and might lead most other economic indicators higher. (Grade C+, up from a C-.) 

We need evidence of more favorable reactions to disappointing earnings and weak guidance. I am encouraged by the better price action in the face of poor earnings results and guidance in a wide range of companies, including Freeport-McMoRan Copper & Gold (FCX Quote - Cramer on FCX - Stock Picks), FedEx (FDX Quote - Cramer on FDX - Stock Picks), Airgas (ARG Quote - Cramer on ARG - Stock Picks) and General Electric (GE Quote - Cramer on GE - Stock Picks). (Grade B+, up from a C+.) 

Emerging markets must improve. China's economy (PMI and retail sales) and the performance of its year-to-date stock market have turned decidedly more constructive, but other emerging markets remain moribund. (Grade B up from a C.) 

Market volatility must decline. The world's stock markets remain more volatile than a Mexican jumping bean. (Grade C+, flat with two weeks ago.) 

Hedge fund and mutual fund redemptions must ease. I am comfortable writing that the worst of the redemptions are behind the asset management industry. Nevertheless, the disintermediation and disarray in the hedge fund and fund of fund industries still have a ways to go. And while brokerage account liquidations appeared to have decelerated last week (coincident with rising share prices), my high net worth brokerage contacts continue to experience account closures and a panicked constituency. (Grade C, up from a D.) 

Marginal buyers must emerge. Low invested positions at hedge funds and by individual investors no doubt fueled March's market rise as the fear of being out has begun to replace the fear of being in. These two classes could continue to be the near-term marginal buyers fueling stocks. Corporate acquirers could also emerge as important marginal buyers, and the recent step up in merger and acquisition activity -- for example, Genentech (DNA Quote - Cramer on DNA - Stock Picks), Petro-Canada (PCZ Quote - Cramer on PCZ - Stock Picks), Schering-Plough (SGP Quote - Cramer on SGP - Stock Picks) and Daimler (DAI Quote - Cramer on DAI - Stock Picks) -- is a concrete indicator that another important marginal buyer has surfaced. As the year progresses, a meaningful upside move awaits a broad asset allocation move of pension funds out of fixed income and into equities. (Grade B, up from a C.) 

The market's internals must improve. I am comforted by a number of improving technical conditions that have emerged since the March low and that have continued in force over the past two weeks since the market has made program off that nadir. Indeed, the conditions of the recent low were different than others -- in sentiment, volume, number of new lows and in intensity. The move from the October lows to the March lows indicated growing fear and gave way to rising cash positions and the loss of hope, but the market's internals were improving. November's DJIA low of 7,552 was nearly 11% below the October low of 8,451, and the March low of 6,547 was 22.5% under October's low. While each new low was more frightening than the prior one, however, there were improving technical and sentiment signals. For example, NYSE volume at the October low expanded to 2.85 billion shares; at the November low, volume dropped to 2.23 billion shares; and at the March low, volume was only 1.56 billion shares. As well, new lows traced decreasing levels: At the October low, there were 2,900 new lows; at the November low, there were 1,515 lows; and at the March low, there were only 855 new lows on the NYSE. Moreover, the combination of last Tuesday's 12:1 ratio of advancing stocks over declining stocks coupled with that day's 27:1 up-to-down volume ratio has not occurred in almost 65 years. Remarkably, yesterday was the fifth 90% upside day in March, which is clear evidence of a broadening market.