Thoughts

Yesterday afternoon, Dallas Fed President Richard Fisher gave a speech that has some significance, but which was not widely reported.

The important element of his speech was that the Fed was unlikely to engage in additional quantitative easing unless it was coupled with a fiscal initiative geared towards adding new jobs in the U.S.

That's the good news.

The bad news is that given the timing of the mid-term election (two months away) and in light of the apparent inroads the Republican Party is expected to make, we are on hold for now.

I would conclude that we have reached a housing bottom but the slope of the recovery will be gradual and disappointing vis-a-vis previous cycles, owing to a number of new influences that will offset the positive factors.

These include, but are not restricted to:

* the decimation of the shadow-banking/securitization industry and markets and its impact on reduced lending and credit availability (especially of a jumbo mortgage-kind);

* community/local banks, an important source of a lot of mortgage capital, are weakened and not likely to return to anywhere near their previous home-lending policies for some time to come;

* the decade of the temporary worker means that more will be renting regardless of the improving economics of home ownership;

* an elevated unemployment rate does not augur well for confidence, which is needed for the consumer to make a substantial investment in a home;

* the existence of an unprecedented shadow inventory of unsold and vacated homes -- it will take time to be absorbed and will weigh on home prices;

* the general view after the 2007-2009 home price shock that housing will no longer be an important wealth creator as it had been in the prior decades;

* as part of the previous factor (and others), the trade-up buyer (a source of important incremental housing demand) is sharply reduced vs. previous cycles;

* the possibility that the administration might even consider policy that could reduce the propensity to buy a home, (e.g. reducing/eliminating mortgage interest deduction) in order to reduce its fiscal imbalances.

The foundation of a housing recovery rests on the affordability index (which is now at a multidecade high), generational low mortgage rates, an attractive home ownership/rental relationship and, most importantly, a two-year-building and pent-up demand, owing to low new-home production vis-a-vis household formation growth.

A gradual recovery in housing is now at hand.

Bull markets are born out of distress -- witness March 2009. Bear Markets are born out of prosperity -- witness 2007.

Liquidating/de-risking out of equities and acquiring/re-risking into fixed income has been the mantra of most individual and institutional investors over the course of the last three years. Since early 2008, retail investors have sold over $200 billion of domestic equity funds, while purchasing nearly $600 billion in fixed-income products. That gap of over $800 billion is unprecedented as is last decade's spread in performance of bonds vs. stocks the largest in history. But history tells us that the S&P 500 performs famously in the following decade and ultimately moves contra to a peak in flows.

In many ways, the sentiment toward equities today is as bad as the extreme experienced at the generational low 18 months ago. Indeed, at Tuesday's close, the market zeitgeist was eerily reminiscent of 1979 in which Business Week published its "Death of Equities" cover.

The fact is that most classes of investors now view U.S. stocks with distrust.

And, as I have previously asked, who is left to sell, especially if the concerns regarding a double-dip prove unjustified?

I continue to view the double-dippers as on the wrong page. There are multiple reasons for this view.

Consider that the cyclical components of GDP, such as autos and housing, now contribute so little to aggregate GDP that the year-over-year impact in late 2010/early 2011 can only modestly impact output. Moreover, with inventories-to-sales so low and with auto and residential investments so far from their longer-term trendline relationship to GDP -- ergo, demand is pent-up! -- a double-dip seems an unlikely event. Even the spent-up consumer's debt-service ratio is at its lowest level since 2000, and, owing to a generational low in mortgage rates, a refi boom is inuring further to the consumers' state.

Certainly, Wednesday's economic releases over here and over there (in China) confirm my baseline expectation that growth is moderating but not likely to decline.

Souring sentiment, reasonable valuations, an absence of inflation, the likelihood that monetary policy will remain easy and the unlikelihood of a double-dip continue to form the foundation of value-creation in equities.

In the fullness of time, there is almost an inevitability that a large reallocation trade out of bonds and into stocks is forming. If I am correct, many investors are now offside.

In summary and from my perch, 10-year Treasuries yielding under 2.60% seem dear and should be shorted while U.S. stocks trading at 12x reasonable 2011 S&P profits seem cheap and should be purchased.

Make no mistake -- the road less traveled will continue to have bumps, and some of those potholes will be with us for some time:

* The securitization market and the shadow banking industry are shattered and shuttered and will no longer deliver credit anywhere to the degree they did in the last credit cycle.

* Residential and non-residential construction will not serve as a driver to growth, and there is little to replace the void.

* Regulation will remain a costly burden on industry.

* It is increasingly obvious that there is a structural increase in unemployment in the decade of the temporary worker.

* A policy of populism geared against the wealthy and large corporations will have negative implications -- higher marginal tax rates will weigh on growth/profitability.

* Fiscal imbalances at local, state and federal levels are unprecedented.

The good news is that most of these nontraditional headwinds -- it's different this time! -- are now recognized by most investors, so the vehicles traversing those bumpy roads seem to be reasonably prepared and relatively well-equipped.

Looking further ahead, the lost decade has passed us, and a new decade is upon us.