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Kass: I'm Sprouting Bull Horns

Doug Kass

"There are two types of minds -- the mathematical and what might be called the intuitive. The former arrives at its views slowly, but they are firm and rigid; the latter is endowed with greater flexibility and applies itself simultaneously to the dive."

-- Blaise Pascal

Bulls, bears, Republicans and Democrats, oh my!

My singular charge (by day!) is to deliver superior investment returns to my investors. To do so, I must remain sensitive to the message of the markets and to the changing list of numerous fundamental inputs, but these days it's easier said than done in a market that seems to have no memory from day to day.

That said, I am beginning to see some light at the end of the market's tunnel.

I have long said that relative to intermediate- and long-term interest rates, stocks are not expensive -- nor have equities, in the main, ever been taken to speculative extremes, though the same can't be said for residential real estate, commodities, derivatives or private equity deals. A host of other factors incorporated in a previous column earlier this year argue in favor of a better market -- perhaps now more than ever, these "good omens" are seeing the light of day.

Several recent developments have conspired to elevate the chances of moving out of this summer's trading range to the upside. Some of the more positive catalysts include:

• A sharp drop in the price of most commodities (especially of an energy kind) will serve as a tax cut to the consumer and even stem the tide of lower disposable incomes that has been so apparent over the last few years.
• The aforementioned reduction in cost pressures (if sustained) decreases the vulnerability of corporate profit margins. A compression in profitability had previously been the source of my concern over the last two years. Alleviating this concern is an important market tailwind.
• With raw costs dropping -- Jim "El Capitan" Cramer gets this! -- and wage inflation nonexistent, inflation has probably peaked in this economic cycle. Indeed, it may now have become the battle past.
• The insular, mainstream media may have underestimated Republican Vice Presidential candidate Sarah Palin and her potential impact on the McCain ticket in the November election. She hit a home run last night in a remarkably wise, poised (even when the teleprompter broke!), scorching and sassy speech. A characteristically positive response was from Hal Stratton, a former Attorney General of New Mexico, who said, "That's what we out West call openin' a whole can of whupass on your opponents." There were also the characteristically critical reactions from the New York Times and Washington Post.
• Regardless of the election's outcome, given the gravitas of the economic downturn, both Presidential candidates will now likely reduce individual tax rates to the middle class and introduce an additional fiscal stimulus package.
• The housing markets, which are at the epicenter of our credit problems, show preliminary signs that the bottom in activity and price declines may be only six to nine months away, even though the magnitude of the recovery remains an ongoing issue. (This morning, Toll Brothers (TOL) reported only 195 home contract cancellations. That's the lowest quarterly level in over two years.) The same may be true for the automobile industry.
• A continuing high (and increasing) level of investor pessimism is reflected in the multiyear lows in the net long positions of the hedge fund community.

Importantly, I have long written this summer that, given the complexity of today's investment issues, I will let the market tell me its story, and Mr. Market is telling a clear disinflationary tale -- Jim "El Capitan" Cramer gets this, too! -- based on the classic relative strength and revival of early cycle sectors (homebuilding, finance and retailing).

This is what market bottoms look like.

So, I am now calling an audible on many of the investments that have occupied my short book, like the Retail HOLDRs (RTH) and a number of other consumer names. Moreover, the better acting early cycle sectors could be joined by the oversold materials and energy groups, which are now looking very much like the mid-July capitulation in the banks.

If this occurs, an upside breakout could happen sooner than later.

"The odds are six-to-five that the light in the end of the tunnel is the headlight of an oncoming train."

-- Paul Dickson

I am not ignoring the obvious headwinds, which include a pernicious credit cycle, a deeply indebted consumer, a hedge fund community in disarray, the world's fractured financial institutions (and the attendant loss of credit availability) and a weakening corporate profits picture, but all of these issues are now well known and quite possibly have been discounted in the current price level and valuation of equities.

Nor am I willing to bet the ranch that lower commodity prices are creating something of a sea change in the form of improving corporate profits, that the relative strength in early cycle stocks will be sustained, that the oversold materials/energy stocks will rebound meaningfully nor that political change (or its investment ramifications) will have a salutary impact.

Though I am a Democrat and a short seller, as I have written repeatedly, there is no place for partisanship in the investment process. I have equal disdain for Polyannas and Cassandras, and I abhor inflexible investors who ignore the message of the market and remain too anchored in unbending dogma.

My investment conclusion?

The light at the end of the tunnel may not be an illusion, but the tunnel might be!

It's time to get more bullish.

Doug Kass writes daily for RealMoney Silver, a premium bundle service from TheStreet.com. For a free trial to RealMoney Silver and exclusive access to Mr. Kass' daily trading diary, please click here.