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The Bullish Stars Are Aligned

This commentary originally appeared on Real Money Pro on Nov. 7 at 7:52 a.m. EST.

As I will discuss in the body of today's opening missive (and in the Kass Model Portfolio update that will follow this post),I am growing more optimistic toward the U.S. stock market.

If share prices remain weak and assuming that my economic and profit expectations are unchanged, I expect to expand my long positions in the weeks ahead. But I will be disciplined, wait for the right pitch and not chase stocks higher.

I have generally been cautious (and underinvested) throughout most of 2011 as I have expressed a view that it was different this time, citing a troika of concerns that would serve as a headwind to domestic economic growth and would limit the upside potential for share price appreciation:
  1. An imbalance between demand and supply in the U.S. housing market as a large shadow inventory of unsold homes would weigh on home prices (and on consumer balance sheets).
  2. Divided and divisive political leadership unable to agree to and enact hard-hitting, pro-growth fiscal policy.
  3. Structural disequilibrium in the labor market, which would lead to an elevated unemployment rate.

Domestic economic growth in the first half came in far less than consensus forecasts and basically supported the above concerns that I had previously expressed, with real GDP rising by less than 1%. And, while there was a great deal of volatility thus far in 2011, the S&P 500 has made little progress and stands today basically unchanged from year-end 2010.

Slowly, most economists (and even the Fed) have finally accepted my long-term view that forward economic growth will be subpar and that the trajectory will be uneven.

Over the past few months, I have written on Real Money Pro that there were four conditions necessary for us to become more optimistic regarding the outlook for stocks:

  1. the market's volatility would need to subside;
  2. the sharp division in Washington, D.C., must turn toward compromise;
  3. forceful policy in the eurozone was necessary to stem the debt crisis; and
  4. I wanted to see a stability/improvement in the hard domestic economic data (which would negate the possibility of an economic downturn or double-dip).

While volatility remains heightened, the other three conditions are slowly turning more positive. And, even as I reflect about the tortuous volatility, do not the fear of uncertainty and the wild daily price moves represent precisely the time when one should be invested?

In the twentieth century, the United States endured two World Wars and other traumatic and expensive military conflicts, the Depression, a dozen or so recessions and financial panics, oil shocks, a flu epidemic, and the resignation of a disgraced President. Yet the Dow rose from 66 to 11,497."

-- Warren Buffett

Before I discuss the slow improvement in the three other factors, I want to emphasize that I am keenly aware of the worldwide risks associated with the impact of the current balance sheet retrenchment and the challenges associated with numerous secular headwinds. The world's economic recovery is imperfect, and with the U.S. economy exhibiting only moderate growth, there is little margin of safety for exogenous shocks. But that imperfection and vulnerability are now universally recognized (contrasted with the optimism that existed a year, six months and three months ago) and are arguably reflected and more than discounted in reasonable/current valuations.
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