Kass: Three Summer Scenarios

Scenario No. 3: The Continued Rally (Probability of 35%)

While giving the scenario only slightly better than a one-third chance, a new up leg is not out of the question. If the replenishment of depleted corporate inventories begins to occur in July, evidence of an impending production boom could be interpreted by market participants as a sustainable economic leg higher (an outcome with which I happen to disagree), which will carry expectations of improving corporate profits. With the appearance that the domestic economy is moving from "less worse" to "better," fixed-income yields would then rise. (The yield on the U.S. 10-year note could as high as 4.25% or 4.50%.) And, as I have emphasized, a large pension fund reallocation out of fixed income into equities could serve as a catalyst to energize stocks and take the averages through the upside of their recent trading range.

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Looking beyond the near term, I would emphasize that I view the two correction scenarios as bolstering the market outlook during the fall-winter period. Both scenarios would serve to build up skepticism, shake up complacency and make it difficult for many investors to get back in. A sideways correction would frustrate the most and wear many investors out. A deep correction would again increase the fear of being "in" compared to the recent fear of being "out." A subsequent rally out of these two scenarios would be fueled by investors chasing strength as even in bear market rallies (1938-1939) there is typically more than one leg higher. By contrast, a continued rally would expose the markets to getting overbought once again and would likely serve to threaten equities in late fall/early winter.