Kass: Ready for the Bear Stearns Challenge?

I would argue that, in the main, Bear Stearns (like Drexel Burnham was) is indeed a one-off situation -- much like when Penn Central shocked the financial system 28 years ago.

While the credit conditions suggest that it is different this time, my investment conclusion is that we are likely at the beginning of the end. As was the case of the Drexel bankruptcy, however, we are not at the end of the current crisis (as the deleveraging process will take more time).

Buying Into Panic

The infinity of political, economic and psychological factors that influence the investment mosaic overloads the senses -- more so today than in most prior periods. Six weeks ago, I evaluated the market's positive and negatives. When I revisit these factors today, I can see the balance tipping over toward the positive ledger -- but only after we digest the Bear Stearns news.

That indigestion could take a day, a week or a month. No one can be sure of the timing.

Here are some (weighing not voting) considerations that could buttress the markets and/or suggest that the current issues could be in the process of being discounted in the markets, forming the basis for the potential for a more constructive view in the days/weeks/months ahead after the panic subsides:

• The curative and clearing process, addressing many of the financial institution's capital issues, has been under way for months. Though the Three Stooges of 21st Century Finance (i.e., the Executive Branch, Federal Reserve and Treasury Department) have been timid and unimaginative, last week's actions by the Fed and the rescue of Bear Stearns are a start in the right direction. And even Bush, Bernanke and Paulson are beginning to recognize the immediacy of the problems -- and the need for outside-of-the-box solutions (like investment banks' access to the discount window).
• We are bottoming, not yet recovering in housing. Some permutation of the Barney Frank/FHA proposal seems inevitable, particularly in an election year. Regardless, home prices are finally descending at an accelerating rate, and the more realistic prices will no doubt begin to attract buyers as credit availability stabilizes. I still do not expect a housing recovery until 2010, but the vision of stability is within sight by next year.
• Corporate balance sheets are in great shape and should buttress the current credit issues.
• Sovereign wealth funds remain flush (though relatively uncommitted) and stand ready to commit opportunistically to shore up capital of some of the U.S.'s largest financial institutions.
• The yield curve's steepening could, in the fullness of time, incent banks to take more risks.
• Corporate profit expectations, which were unrealistic until recently, are being pared quickly and are catching up to my downbeat projections. Fourth-quarter 2007 earnings (including financials) dropped by over 20% and are now anticipated to drop by nearly 10% in first quarter 2008. More importantly, unlike prior recessions, the credit problems are not trickling into other market sectors. Taking out financials, fourth-quarter 2007 profits rose by about 11% and are estimated to expand by about 7% in the current period.
• Over the last 50 years, job losses (a lagging economic indicator) have coincided with economic stabilization and a positive turn for equities. For example, reports of midsummer 1990 job losses were followed by a recovery in stocks that began in October, only two and a half months later. Ten years previous to that recession, stocks stabilized a month before job losses began occurring.
• Stocks have declined by 20% within a six-month period for the fourth time in a quarter of a century (1990, 1998, 2000). In the 12-month period following the 1990 and 1998 corrections, stocks rallied by 34% and 39%, respectively. The 2000 correction, however, begot a full-fledged Bear Market.
• As I have noted previously, unlike previous bear markets, equities were not the subject of speculation at the top; commodities, residential and non-residential real estate, and private equity were.
• If corporate profits avoid a major slide in 2008, stocks are inexpensive relative to short- and long-term interest rates. Indeed, with a seeming bubble in the bond market, a broad reallocation of assets out of fixed income and into equities seems possible.
• With the speed and momentum of the credit crisis intensifying coupled with a continued weakening in economic activity (especially of a job kind), the negativity bubble now appears so inflated that it could be ready to pop. For example, the equity-only put/call reached an all-time high on Friday, the Investors Intelligence (of market letters) survey showed bears rising to levels not seen in six years and demonstrated one of the sharpest weekly increases (to 43.6%) in years, the AAII survey (of individual investors) came in at the largest level of bears (at 59%) in nearly 20 years, and the consensus survey of futures traders were (only 23% bullish) at the lowest levels seen in over five years. These instances display a negative sentiment extreme rarely seen -- even at bear market lows.

Intermediate-Term Opportunities Are Emerging

Most should continue to maintain below-average sized positions in order to take advantage of what Mr. Market presents, as an opportunistic approach to trading/investing remains my mantra. Erring on the side of conservatism remains an appropriate strategy for individual investors.

Frankly, it's time to let the market do its talking, not the pundits. My guess is that we will "know" the answer sooner than later and that the outcome (at some undefined time) will be more positive than most appear to believe this morning.

I am now making the hardest decision -- again, only for the most facile traders/investors -- as I am getting more constructive (mildly bullish) on my intermediate-term market outlook on the basis that we are now at the beginning of the end of the credit crisis.

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Doug Kass is the author of The Edge, a blog on RealMoney Silver that features real-time shorting opportunities on the market.

Know What You Own: JPMorgan operates in the financial services industry, and some of the other stocks in its field include Citigroup C, Goldman Sachs GS, Morgan Stanley MS and Merrill Lynch MER. These stocks were recently trading at ($18.21, -7.94%), ($143.80, -8.31%), ($34.18, -13.55%) and ($39.04, -10.27%) respectively. For more on the value of knowing what you own, visit TheStreet.com's Investing A-to-Z section.