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Kass: How a Year-End Rally Could Materialize

Stocks in this article: GS TOL MS

This blog post originally appeared on RealMoney Silver on Nov. 17 at 8:03 a.m. EST.

For nearly a decade, a surplus of cash has led to a shortage of common sense in the lending and borrowing of capital, and the markets are now in disarray as a financial hurricane has wreaked havoc upon the world's economies.

In a haze of uncertainty, market participants' visions of our economic future remain cloudy. That uncertainty and the loss of investor confidence and liquidity are manifested in historic intraday swings, suggesting that investors see a very wide range of possible economic outcomes.

A crisis 10 to 15 years in the making does not get fixed overnight.

There are going to be difficult days ahead, but, as I have noted, there are tentative signs of improvement. For example, the actions taken by the U.S. and other nations are beginning to have an impact. Though credit remains dear, credit markets are beginning to thaw. Businesses are slowly gaining access to essential short-term financing.

In other words, a measure of stability is returning to the financial system, even as equities around the world plummet.

Today, as investment icon Howard Marks recently stated, negativity reins supreme, possibly opening the door of opportunity for the contrarian.

I find that I often end with a quote from Warren Buffett, and often it's the same one:

    The less prudence with which others conduct their affairs, the greater the prudence with which we should conduct our own affairs.

But now I want to talk about the flip side: When others conduct their affairs with excessive negativism, it's worth being positive. When others love 'em, we should hate 'em. But when others hate 'em, we can love 'em.

In "The Tide Goes Out" in March, I listed the stages of both bull and bear markets. I said that in the terminal third stage of a bull market, everyone is convinced things will get better forever. The folly of joining that consensus is obvious; people who invest thinking there'll never be anything to worry about are sure to get hurt.

In the third stage of a bear market, on the other hand, everyone agrees things can only get worse. The risk in that -- in terms of opportunity costs, or forgone profits -- is equally clear. There's no doubt in my mind that the bear market reached the third stage last week. That doesn't mean it can't decline further, or that a bull market's about to start. But it does mean the negatives are on the table, optimism is thoroughly lacking, and the greater long-term risk probably lies in not investing.

The excesses, mistakes and foolishness of the 2003-2007 upward leg of the cycle were the greatest I've ever witnessed. So has been the resulting panic. The damage that's been done to security prices may be enough to correct for those excesses -- or too much or too little. But certainly it's a good time to pick among the rubble.

-- Howard Marks, Chairman, Oaktree Capital Management (October 2008, " The Limits to Negativism")

The negativity is not surprising as economic growth is plummeting and unemployment is on the ascent. The brokerage community is in disrepair. Bear Stearns and Lehman Brothers have failed, and even Goldman Sachs (GS) has been hobbled. Credit remains dear, and investment expectations have been ratcheted down. Individual and institutional investors are almost in a state of shock today as money has been withdrawn in record amounts from mutual funds and hedge funds. (The latter community will be a shadow of its former self by early 2009.)

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