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Kass: Buy It Like Buffett

At the core of my intermediate-term optimism is that, as a result of the unprecedented policy moves, investors soon will be less preoccupied with unconventional credit risk and will move back toward conventional recession concerns. (This development is fully documented in this weekend's Barron's column, " A Thaw in the Freeze," written by Randy Forsyth.

My more optimistic tone stems from the following items:

  • Credit mending. The credit markets are beginning to (and will continue to) thaw. Three-month Libor is improving and has traded down to about 4.00% this morning, down from 4.20% at Friday's close and from a 4.50% peak earlier. Three-month Treasury bills have increased, doubling on Thursday and Friday. As a result, TED spreads contracted to about 3.60% on Friday and have improved further today. Friday's close was their first close under 4% in six trading days and the third lowest close of the month. Also improving this morning are the Libor/overnight rate spread, the mortgage rate/Treasury yield spread and the two-year bank swap spread (now back to pre-Lehman levels).
  • The banking fix is going global. Over the weekend, officials from South Korea ($130 billion in state guarantees and capital injections), the Netherlands (through an infusion to ING (ING - Get Report)) and Latin America joined the global rescue efforts.
  • Corporate balance sheets are healthy. Excluding financials, the balance sheets of American corporations are relatively healthy and less dependent upon the short-term debt markets than at any time in history. Moreover, unlike in prior cycles, it is important to recognize that there have not been the excesses in capital spending that have threatened previous cycles.
  • Inflation has peaked. For now, the broad-based drop in commodities is being largely ignored, but, over time, this serves as a tax cut to the consumer and will likely buoy historically high corporate profit margins.
  • Housing has hit bottom. Though a recovery in housing has been delayed until 2010 (at the earliest), the rate of decline in home prices is decelerating (albeit from low levels).
  • Consumer confidence has also hit bottom. Again, it will be a long road back, but the bottoms are being put in.
  • Takeover activity is on the rise. Very quietly, merger and acquisition volume is on the ascent and occurring at substantial takeover premiums through the use of cash (not Chinese paper) as deal currency. This morning's announcement that Exelon (EXC - Get Report) is offering over $6 billion for NRG Energy (NRG - Get Report)is another step in the right direction.

I remain a realist, as I continue to believe that the recession will linger and that reduced corporate profit expectations could still be too high with a background of disappointing and inconsistent worldwide economic growth. When I begin to use verbs like bottoming, peaking and mending, however (words that I haven't used in years), it represents a sign of a potentially more positive market framework, and it likely means that we can begin to start to consider whether a more benign market environment is on the horizon as the forced selling and hedge fund liquidations moderate.

Of course, what would constitute a full clear short-term bullish call would be evidence that the recession has been discounted in share prices -- that is, if individual stocks and the collective market began to respond more positively to profit downgrades and poor macro indicators. The current phase of the market cycle is particularly murky because of the great hedge fund unwind that has resulted in the recent vortex in selling.

While the great hedge fund unwind comes with a degree of uncertainty regarding the immediate-term outlook and delays the clarity of a more bold and positive short-term call, we must also recognize that forced (and sometimes artificial) selling over the course of stock market history (e.g., the end of the Nifty Fifty Era in 1974, the dumping of stocks during the Portfolio Insurance plunge in 1987, the margin calls on Internet stocks after the 1998/early 2000 euphoria, etc.) has nearly always marked a opportunistic entry point leading to an upturn in stock prices.

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