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Kass: Tug of War

This blog post originally appeared on RealMoney Silver on Feb. 24 at 7:56 a.m. EST.

While the magnitude of the drop in the Conference Board's Consumer Confidence Index seems suspicious and unjustified based on previous indicators (e.g., a more upbeat February University of Michigan confidence reading, growth in hours worked, stabilizing home prices, improving retail sales and other forward-looking economic reports), yesterday's release does reinforce my view that the economy on the ground is not as upbeat as the view of the economy in the charts.

As I have written repeatedly, with so many cyclical and secular issues and headwinds to growth and a widening gap between the operating and financial health of large businesses vis-a-vis small businesses and the consumer, there are many more economic and market outcomes than usual that, in the aggregate, could offset the growing consensus of smooth and self-sustaining growth.

I continue to recognize that stocks are not meaningfully overvalued and that downside risk is limited. Stocks, unlike other assets classes (e.g., fixed income, private equity, residential and nonresidential real estate and commodities), have not had their valuations stretched. Most already expect a relatively shallow economic recovery. Also, inflation and inflationary expectations are subdued, and an elevated unemployment rate and large output gap are among the many reasons why the Fed will be on hold and the curse on cash will be intact for most of 2010.

Of late, there has been an increase in optimism with regards to profit growth based on better sales, improving margins (lower-than-expected unit labor costs) and rising cash flows, which are leading toward more aggressive share buybacks. The consensus for 2010 S&P 500 profit forecast is now moving toward (and even over) $80 a share, and the 2011 consensus is leaning toward the view that profits will exceed the previous 2007 record level of $92 a share.
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