Doug Kass Calls a 2009 Market Top on Overly Bullish Psychology

Includes: FXI, PGJ, SPY
by: John Furlan

Veteran money manager Doug Kass has an interesting article this morning on titled, “Market Has Likely Topped.”

Because it is on a subscription site, I will limit my quote to his bottom line: “I believe that the markets are now overshooting to the upside and that the U.S. stock market has likely peaked for the year.”

By the way, usually Kass’ key articles such as this one will appear shortly afterwards ,on the's free sister page, so look for it there a little later if you’re interested in the details.

Kass’ major calls, like this one, the one that he made absolutely nailing the March 6-9 bottom, and the many courageous warnings he made leading up to the financial crisis, tend be very well thought out.

(A few friends sometimes think that Kass bobs and weaves short-term a little more than they like. I feel that comes with the territory of very frequent writing about a very dynamic market. Make no mistake, this article is a major call by Kass.)

Calling Tops vs. Trend Following

In Cramer’s reply to Kass’ article, he respects Kass’ call, due to its reasoning and Kass’ credibility, saying “Doug calls the market. I am a scale-seller into strength.”

I feel that is an important distinction, one that I’ve made between trend followers and market callers in my Aug 4 article on that issue.

Very simply, until the market actually does start to top, as perhaps China’s might be doing, it’s someone’s opinion, no matter how well informed and well reasoned, until the facts start to confirm it.

Changing Market Psychology Is the Key

In his key articles, Kass often boils down his reasoning into very clear, succinct lists of key fundamental factors supporting his views. Frankly, his list of 10 items in today's article could have been made during much of the rally, especially the latter months, but that didn’t stop the market from going up.

Those fundamental reasons have always been there, as Kass himself essentially acknowledges he foresaw these conditions when he first turned bullish back in March, which is true.

So what might be about to change now? Market psychology. Kass thinks it’s gotten too bullish.

Thus, why Kass thinks the market has now topped is as much, if not more, a “subjective” factor of market psychology as it is to the “objective” fundamental factors in his list of 10 items. I.e. the market psychology stuff he writes about in the paragraphs preceding his list of 10 fundamental factors is just as, if not more, important than the stuff in the list itself.

Basically Kass, a very smart guy with years of market experience and great market connections, often has a very good feel for extremes in trader/investor sentiment that usually precede a dramatic change in what I often call the "market's mind" in my Seeking Alpha articles, as he describes in those paragraphs preceding his list.

Possible Shift on China Market, So Far the Critical Global Growth Story

I do think Kass has omitted, probably inadvertently due to time pressure, because I’m sure he knows this, a possibly key recent shift in market psychology, namely the recent -20% correction in China’s Shanghai Composite Index.

I won't discuss here China's weight in the global economy, although it does factually account for far more of global growth than most think, sometimes up to 50%.

What is very clear is that China’s economy and equity markets have led the global markets up, with the Shanghai Comp bottoming all the way back in late Oct, 4 months before the Mar 6-9 bottom in the U.S. equity market.

That’s because so far in this cycle China still is the only obvious growth story, and asset booms/bubbles big enough to create major market and economic turns must be obvious eventually to even the most oblivious investor, by definition.

If investors start to question the staying power of the China growth story, right at the moment there is no other engine in the "twin engine" U.S.-China led global economy, unless and until the U.S. finds its own new asset boom/bubble, something it seems to be having a lot of trouble doing still.

Those American-as-apple-pie favorites, real estate speculation and tech innovation, that have traditionally filled the asset boom/bubble role in the past don't seem to be doing so as of yet.

I don't think a bubble in government debt, e.g. see the new OMB and CBO long-term deficit projections raised yesterday, is going to have the same positive impact, it most likely would have a highly negative long-term one.

Btw, the current importance of the China growth story is why I have focused on the issues with it the past 4 weeks in my weekly Seeking Alpha articles, at the end of this article I show the China “factor” summaries for those articles, each week I list the key developments for 16 key factors and summarize them in a “Market Status” section.

I changed my factor rating on China from ++, the highest, to +, on July 31, before China's sharp market correction after its Aug 4 top.

Technicals vs. Fundamentals vs. Using Both

Back to Kass. "Pure" technical analysts purport to be able to read the "market's mind," free of the distracting details of myriad fundamental facts, from price and volume patterns.

Veteran savvy money managers like Kass often also use charts, but since they are also steeped in the fundamentals, they are able to compare the facts with the market's perceptions of those facts, and see the subtle changes at the margins in how the market is starting to react to them.

That is something that neither strictly technical nor fundamental analysts, looking from their separate "disciplines" only at the perceptions (technicals) or the facts (fundamentals), respectively, can do. That's a big advantage for very savvy money managers like Kass, though they might not put it this way, some may not even be consciously aware of it in this way, though they very definitely do know they have an edge.

Strict fundamental analysts just can never grasp the critical importance of key changes in market psychology. They look at the world like a simple linear mathematical equation. They always are completely baffled as to why fundamental factor X that moves up market Y yesterday doesn't do so tomorrow. It usually takes them weeks, even months, to realize that investor psychology has completely reversed, some never get it.

Watching their bafflement if/when market psychology changes can be bemusing. It routinely happens in Wall Street equity morning meetings, when a stock analyst would tell the sales force the same bullish story he told them yesterday, expecting the same positive response, yet the leading brokers, responding to the subtle shifts in mood of their most astute investor clients, would visibly show their new lack of interest, much to the bewilderment of the befuddled analyst.

If Kass is right and the "market has likely topped," then current increasing political conflicts could get much stronger real fast, if the public's dissatisfied mood starts to be exacerbated by a renewed global equity market downturn, one reflecting and feeding back on the other.

My China Key Market Factors Over the Past 4 Weeks

Here are the China “factor” summaries from my last 4 weekly articles. I changed my factor rating on China from the highest, ++, to + on July 31, before the sharp correction in August. BTE is abbrev for “better than expected” usually followed by the consensus estimate, WTE for worse. There are 16 key factor summaries each week.

Aug 23 article: + China: CBRC issues draft rule to tighten bank capital requirements; Aug bank loans estimated at 500 B yuan could exceed Jul 356 B (-77% from Jun); Bloomberg Aug 19: “Earnings for Chinese companies that reported since July 8 have trailed analysts’ estimates by 12 percent”; China July FDI -35.7%, 10th monthly decline.

Aug 16 article: + China: Shanghai Comp fell -6.6% last week, worst since Feb 27; July industrial production 10.8% (WTE 11.5%); July new lending 356 B yuan (WTE 500 b), down from 1.53 tr in June; July urban fixed asset invest 32.9% (WTE 34.0%; July retail sales 15.2% (BTE 15.0%); July exports -23%, down from -214% in June; July money supply 28.4%; Q2 GDP ultra-strong seq growth expected to moderate in 2H; GS raised 2009 and 2010 GDP from 8.3% to 9.4% and from 10.9% to 11.9%; money-market rate declines -94 bp last 2 weeks; HK’s Li Ka-Shing, Asia’s 2nd richest, says: “I won’t buy stocks today.”

Aug 9 article: + China: China said it will scrutinize stock market gains, without much elaboration on how. Official July PMI rose slightly to 53.3 (from 53.2), electricity output 8.4% yr-yr in 2nd 10 days of July, indicating June industrial upside momentum continues. 1H earnings will be reported in Aug. Bank loans are starting to fall, about 500 B yuan in July from 1.23 trading month average in frenetic 1H; Shanghai Composite fell the last 3 days of the week, its first 3-day decline since week of May 18, on traders' focused on whether China will tighten its “moderately loose” monetary policy, e.g. raising capital adequacy ratios, in response to increasingly speculative equity (individual investors opened more than 700k accounts last week, the most since Jan 2008) and property markets (sales up 45%, prices in major cities 30% ytd). Housing transactions may be slowing slightly. Details start emerging on what may be China’s largest ever bank fraud in Guangzhou. Everbright Securities' first brokerage IPO in almost 7 years. GM's best July car sales ever, up 78%. China may top the U.S. as the world’s largest mfr by 2015 according to IHS Global Insight.

July 31 article: + (++) China: consensus GDP estimates of 8.5% in 3Q and 9% in 4Q, peaking over 10% in early 2010; CCP Politburo and China’s central bank affirm “moderately loose” monetary policy; regulators warn banks not to divert loans to financial markets; Shanghai Composite down -5% Wed, most in 8 months, on concern government will curb investment; State Construction world largest IPO in 16 months, price up 56%, 2.5 B shares traded on 1st day, 51x 2008 earnings; Chinese stocks at 35x reported earnings; Shanghai Composite at 26x est earnings; Bank of China, largest lender in 1H, “will continue to expand lending”; China Construction Bank to cap 2009 loan growth at 900 B yuan after 709 b. in 1H; traders target Fibbonaci 50% retrace of Shanghai’s huge decline at 3,894; property boom expected to take over from infrastructure spending; money-credit growth of 28-34%, concerns about exit strategy previously popped up in government bill sales.