Kass: The Case for a Summer Snooze Fest

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 have the nerve to get back in.... 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 a more serious correction.
-- Doug Kass, "Three Summer Scenarios" (June 22, 2009)

Stated simply, I see the current correction as a normal reaction to a seismic rally from the unprecedented and compressed levels of early March.

My Updated and Current Market View

Consistent with my expectations of a sideways correction, the world's stock markets appear to be poised to go to sleep for the balance of the summer.

Over the course of the next two months, I expect the S&P 500 to trade in a relatively narrow range of between 850 and 925.

Here's why I find that there are few catalysts that would move the market in any meaningful direction from current levels:

• Second-quarter earnings will produce little in the way of surprises. While being nothing to write home about, corporate profits should continue the trend of the previous quarter, exhibiting tepid top-line sales growth, but profits will be buoyed by drastic cost cutting.
• Market participation should be especially light. Not only is it summertime, but the wounds of 2007-2008 must be allowed to heal. Long weekends (taking off Fridays) will likely grow longer (as many will also take off Thursdays or Mondays).
• Macroeconomic statistics should continue to stabilize, but the progress should not meaningfully deviate from consensus expectations. Housing will be aided by lower pricing, a continued improvement in affordability and in a reduction in the cost of home ownership relative to renting. The replenishment of manufacturing inventories will stoke modest third-quarter GDP growth but will be muted by a large output gap. Employment statistics will get "less worse," but, again, the recovery will be modest in scope and settling of the double-dip debate will linger. All in all, the principal signs of economic activity that I expect to be reported in July through September will not be enough to produce an upside surprise but neither will it be too little to generate meaningful downside momentum in equities.
• With little in the way of substantive change in economic growth expectations, commodities, too, should be on snooze mode.
• Political initiatives should be modest in July and August as our leaders take leave of Washington, D.C., and also vacation.
• I expect little in the way of hedge fund or mutual fund flows (inflows or outflows) to generate a material change in the supply and demand for stocks, and with fixed-income prices (and yields) exhibiting limited fluctuation, the reallocation of pension plans into stocks and out of bonds will likely ebb in the months ahead.
• With valuation arguably at an historical mid range, P/E multiples seem to be reasonably fair and not subject to a major move in either direction.
• It's hard to see a meaningful swing in sentiment under the aforementioned muddle-along economic setting that contains few surprises.

In summary, last weekend's Independence Day celebration might have already marked the end of the market's summer fireworks and of the market's decline, as the corporate profit and economic pictures (along with other factors) will likely remain cloudy, inconclusive and absent any surprises. Also contributing to the possible snooze fest are reasonable valuations (against normalized profits), midrange sentiment conditions and the absence of meaningful fund inflows or outflows. (If my forecast of a market chill and slumber are met as an 850-to-925 base is built in the S&P 500, selling option premium might be the most productive investment strategy during the summer of 2009).

The next important move will require some modest patience as summer is over in only two months or so. Fortunately, the fall holds promise for the stock market.

My baseline expectation is that the expected summer snooze fest could be followed by a meaningful, maybe even an explosive and certainly playable up leg that, from my perch, should be sold into in anticipation of the first half of 2010's double-dip and within the context of an extended period (in years, not months) of inconsistent and lumpy growth that will be difficult for both corporate managers and investment managers to navigate as the nontraditional headwinds gain strength and impact.

Doug Kass writes daily for RealMoney Silver, a premium bundle service from TheStreet.com. For a free trial to RealMoney Silver and exclusive access to Mr. Kass's daily trading diary, please click here.

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Know what you own: Some of the most active stocks in Thursday's midday trading include Bank of America (BAC Quote), SPDRs (SPY Quote), Financial Select Sector SPDR (XLF Quote), Alcoa (AA Quote), Citigroup (C Quote), PowerShares QQQ (QQQQ Quote) and General Electric (GE Quote).