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Kass: From Generational Bottom to Cyclical Top?

Stocks in this article: TSLATBFTLT

In valuation and investor sentiment today we seem to be at the polar opposite of 2009.

Earnings. As a generalization, I would say that the one mistake that the bears made in 2009 was to look at stated or nominal S&P earnings and to attach a P/E ratio to it in an attempt to determine where we are in the market cycle. Back five years ago at the bottom of the market, the S&P 12-month trailing earnings approximated $45 a share. At 666 on the S&P, the near-15x P/E ratio was nothing to write home about.

But back then I made the argument that rather than looking at stated corporate profits we should be looking at normalized profits -- that is, earnings power adjusted for a normalized economy. I was using normalized profits of about $70-$75 a share for the S&P 500 at that time, making the P/E at only about 9x exceptionally attractive.

Let's contrast that with today's estimated 2014 S&P profits of approximately $120 a share. I have argued and I continue to argue that nominal profits are overstating the health of corporations (just as the health was understated in 2009). Profit margins, in particular, at nearly 70% above the average over the past six decades and at the highest level since 1955 overstate normalized profitability.

So, are we making the same mistake in attaching P/E ratios to stated/nominal earning s today as we did back in 2009?

Investor sentiment. On the issue of speculation, there is little question that there are now pockets of speculative excesses in the IPO market, biotech and elsewhere (e.g., social media and in certain disruptors such as Tesla (TSLA)).

There is also little question that we are in a bubble in the belief that the Fed and monetary policy can by itself lead to a self-sustaining domestic economic expansion.

But it is the area of investor sentiment in which we seem to be at opposites.

In 2009, hedge funds were at their lowest net long exposures in several years. investor sentiment, as expressed in AAII and Investors Intelligence, was similarly distraught.

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