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The Fed and Small Business Optimism: Best of Kass

Doug Kass

NEW YORK ( TheStreet) -- Doug Kass of Seabreeze Partners is known for his accurate stock market calls and keen insights into the economy, which he shares with RealMoney Pro readers in his daily trading diary.

Among the posts this past week were entries about the Federal Reserve and small business optimism.

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Facing Reality
Originally published on Thursday, July 11 at 1:15 p.m. EDT.

Not only may have the Fed lost the bond market, but, my concerns are even more basic -- namely, that massive policy intervention is simply not working.

At best, the economy is growing only between 1% and 2% in real terms as the Fed's balance sheet has risen from under $700 billion in 2008 to nearly $3.6 billion at the current time.

The reality is that the U.S. might be in a liquidity trap (lite) and the Fed is pushing on a string.

From my perch, the implications for profit growth and valuations are not as promising as the market is reflecting today.

Facing Reality (Part Deux)
Originally published on Thursday, July 11 at 1:35 p.m. EDT.

All risk assets seem to rise in price every time the Federal Reserve chairman states that he will continue to be accomodative.

But what he is really saying is that massive monetary easing is not working, so the Federal Reserve is forced to keep injecting liquidity into the system.

So, in reality, stocks in particular are rising when Bernanke is saying that the Fed is failing to catalyze the domestic economy.

How does this make sense?

Of course it makes no sense, because the U.S. economy is in a light form of a liquidtiy trap in which the lifting of asset prices (and net worth), which is supposed to result in a rise in consumer spending, is simply not working.

At some point the markets will reflect this.

Losing Confidence
Originally published on Tuesday, July 9 at 8:57 a.m. EDT.

The National Federation of Independent Business released its small-business optimism index for June just now.

This series is typically not market-impactful.

At 93.5, compared with expectations of 94.9 and May's reading of 94.4, it came in at a one-year high but only because the index has been range-bound for one and a half years. The long-term average of this series is 98, well above the June print.

Small businesses are still negative, and the percentage of firms anticipating an improvement in the economic outlook (better sales) dropped to only 5% (a loss of 2 points).

Overall, tying this report to other measures of business confidence suggests stability but little upward thrust. There is a modest improvement in hiring, but most manufacturing indices (e.g., ISMs) are mixed, inventories are not building and capital spending relative to profits is low by historic standards.

On this score, watch the potentially nascent rise in unit labor costs (payrolls), as productivity gains seem behind the sector. As well, the recent U.S. dollar strength and still-modest top-line growth exposes profit margins, which are at multidecade highs and are the Achilles' heel to (too high) second-half corporate profit growth expectations. With basically flat sales growth, it is hard to see business loosen its purse strings going forward.

The volatility seen recently in the fixed-income markets when combined with the aforementioned challenging earnings outlook could limit market upside.

My view is that the S&P 500 has 50 points to the upside and more than 100 points to the downside, an unfavoraborable reward vs risk.

At the time of original publication, Kass was short SPY.

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