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Kass: Are We Overbought?

This blog post originally appeared on RealMoney Silver on April 27 at 8:04 a.m. EDT.

Over the past six weeks, the U.S. stock market has shown some upside.

The equity rebound has been based on a number of salutary factors -- the most important being evidence of a stabilization of economic activity -- and a growing recognition that The Great Decesion (somewhere between a garden variety recession and The Great Depression) was not destined to morph into something worse.

The question at hand, with the current 870 level on the S&P 500, is whether the advance can drive further in the face of a number of unconventional headwinds that investors have little experience or perspective in dealing with.

While I am of the expectation that a generational low was put in during the first week of March, the tension between deflationary and inflationary influences remain the backdrop and setting for the market's continued tug of war.

The investment mosaic remains a three-legged stool. Broadly speaking, the legs include fundamentals, valuation and sentiment.

Fundamentals: The mustard seeds of growth are taking root, but we should not be too complacent as the emergence of rising interest rates and higher individual and corporate tax rates in the year ahead pose the greatest fundamental risk to the domestic economy's slipping off the tracks of recovery. These factors could serve to put pressure on an already vulnerable consumer and could serve to jeopardize a recovery in corporate profits and potentially lead to a double dip in the domestic economy in late 2009/early 2010.

Valuation: Naturally, with stocks well off their depressed levels, valuation is no longer stretched to the downside. Stocks now appear more muddle-valued after seemingly pricing in depression.

Sentiment: According to ISI's Institutional Equity Managers and Hedge Fund surveys and other sentiment indicators, institutional managers have somewhat expanded their net long exposure, and investors are becoming slightly more optimistic. Nevertheless, unlike the strong rallies in 1975, 1982 and 2003, sentiment has not turned meaningfully more positive.

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