Kass: Merits of Market Agnosticism

The Beginning of the End (of the Bear Market)

A more bullish case is not hard to make these days. I have made it and so have others on this site and elsewhere.

In a recent lunch, Greg at Mega voiced to me a sound, rigorous logic in his expression of a balanced and more bullish (though not adamant) case. It's good reading in its presentation of logic and in its sense of history.

In summary, the principal and traditional determinants of the U.S. stock market's future course (fundamentals, interest rates, valuation, technicals and sentiment) are all beginning to point to (or have already turned into) positive territory.

• Fundamentals: Economic expectations are subdued and many of my credit-induced concerns are in the generally accepted consensus. Though most corporate profit forecasts are still too optimistic, they are coming down posthaste. Importantly, the process of curing seized-up credit markets and of remedying what ails the world's financial institutions is proceeding rapidly.
• Interest rates: By any measure, equities are inexpensive against interest rates.
• Valuation: Even against a 10% haircut of consensus forecasts for 2008-2009 corporate profits, the U.S. stock market has value.
• Technicals: Stochastics, oversold, put/call activity and other technicals measures are flashing green.
• Sentiment: Overall negative sentiment is perhaps the best reflection of investors' bearishness today, and the negativity bubble has never been as inflated as participants' expectations have fallen to depths unseen in years.

Are all the conditions of a market bottom in place? Of course not, they never are. Or at least it is unlikely that I will be able to "call the bottom."

The current obvious indecision and manic nature of the markets (without memory from day to day) when coupled with near-panic and emotional conditions speak to a bottoming (not topping) action.

Buffett nailed it years ago when he wrote that "most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can't buy what is popular and do well." As always, timing is the unknown element to the market's riddle, but as legendary technical analyst Walt Deemer once so succinctly exclaimed, "When you should buy, you don't want to."

That time was a week ago.

But Not the Beginning of a Bull Market

"Against this backdrop, what's really perplexing is that Wall Street analysts don't think that a weak 2008 will cast doubt on the vigor of next year's results. On the contrary, in what I think is fundamentally flawed logic, they have maintained the level of their 2009 estimates where they were so that downward revisions to 2008 earnings actually boost the 2009 growth rate. Street estimates for 2009 S&P 500 earnings growth have been revised up to 15.5% from 14.7% at the beginning of January (for details, see "Business Conditions: Bouncing Along the Bottom," Global Economic Forum, March 14, 2008). By comparison, we expect a 5.9% increase in 2009 after-tax economic profits (following a contraction in 2008) that would leave the level below that in 2007."

-- Richard Berner, Morgan Stanley

Just because a bottom has been made doesn't mean that we are off to the races.

My biggest concern is that earnings expectations, which are the key metric in evaluating future stock prices, remain too elevated. (More on this in the next few days.)

As well, the credit markets remain in a sorry state, increasingly decoupled from equities and showing limited improvement. What I now see happening is that, essentially, the banking industry is being forced to extend loans during a credit bear market at bull market prices.

In a sign of last resort during the credit bear, companies -- CIT Group CIT, for instance -- are being forced to draw down credit lines, often at interest rates that are below market and with associated fees that, too, are below market to the banks. This is occurring at a time in which banks are trying to reduce their balance sheets, and its serving to curtail lending and credit availability elsewhere -- for example, in consumer loans and mortgages. (More on this as well in the next few days.)

In summary, as we move toward the end of 2008's first quarter (and with it the attendant "marking up" of positions) coupled with the current price momentum, I can clearly see some continued market strength.

Nevertheless, given my concerns on the corporate profit and credit fronts, the week of March 24 might be an excellent time to take bets off (long and short) that aren't of high conviction until we see a softball right over the plate.

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: BSC operates in the financial services industry, and some of the other stocks in its field include Goldman SachsGS, Morgan StanleyMS, Merrill LynchMER, Bank of AmericaBAC and Lehman BrothersLEH. These stocks were recently trading at ($180.94, +1.15%), ($49.13, +0.78%), ($48.00, -0.79%), ($40.99, -3.44%) and ($45.21, -3.07%), respectively. For more on the value of knowing what you own, visit TheStreet.com's Investing A-to-Z section.