Kass: Dry Your Tears With Cold Hard Cash

With the exception of the most dogmatic (namely, being of a Ben Stein-kind), many observers are downgrading their economic expectations. Ironically, even those more adamant proponents of Goldilocks -- including Sir Larry Kudlow and Dr. Arthur Laffer -- are calling for 50- to 100-basis-point Fed interest rate cuts. Go figure.

So, the burden for 2008 P/E expansion seems to rest uneasily on the shoulder of lower interest rates.

To be sure, we should not ignore the market's multiple to government and corporate bond rates, as the earnings yield to bond yield spread is at a level consistent with a market bottom (not a market top). Nevertheless, a good amount of the recent yield decline represents a flight to quality, which could be fleeting, and the growing recognition that economies are faltering.

As to the future direction of interest rates, my view is that, even despite the U.S. economic weakness, central bank diversification efforts coupled with persistently high inflation in energy products, wages and commodities will cause the yield on the 10-year U.S. note to rise in 2008. Even if I am wrong, however, and interest rates drop, putting the onus of higher P/E multiples on lower interest rates seems to be a stretch given the eroding sequential trend and likely lower level of 2008 profits.