The stock rebound since mid-June has turned some investors bullish on the market. Doug Kass, a columnist for TheStreet.com’s Real Money Pro, isn’t one of them.
“The swiftness and size of the rise in equities last month has driven the markets back to valuation levels that concern me,” he wrote.
The S&P 500 index has jumped 11% in the last month, “reducing the general attraction of equities and posing the risk of more negative outcomes for stocks,” Kass said.
In the week of Aug. 8, Kass spoke with legendary investor Leon Cooperman. The former chief of Omega Advisors told Kass that while nominal corporate profits are strong, that’s not the case after adjusting for inflation.
Consumer prices soared 8.5% in the 12 months through July.
Cooperman sees fair value for the S&P 500 at about 18 times projected earnings of $230 a share. That would put the index at about 4,140, down 3.3% from its recent quote of 4,283.
“However, if we get a recession next year, profits can drop to $180 per share,” Kass said. “Using a 20-times price-earnings multiple yields 3,600 for the S&P 500,”
Cooperman says January’s record 4,797 for the index may not be broken for several years.
Kass thinks the market is overcooked. “An oversold market in June has become overbought on every measure we look at. Short positions are being aggressively covered, and fear of the return of capital has quickly morphed into the fear of missing out.” Short positions are bets that stocks will fall.
Much of the recent stock-market increase stems from investors’ view that the Federal Reserve will soon make a "soft pivot" away from interest-rate increases, Kass said.
“We are of the view that market participants have misinterpreted Fed Chairman [Jerome] Powell's intentions,” Kass said.
“While I have been in the ‘peak-inflation’ camp, I think inflationary pressures will be more stubborn than the consensus expects. ... I expect a continued hawkish Fed and, with equities elevated, there is renewed market vulnerability.”
Bank of America Is Skeptical, Too
Kass isn’t the only expert skeptical of the recent stock rally.
“Only 30% of our bull market signposts" -- things that happen before a market hits bottom -- "have been triggered, versus 80% in prior market bottoms,” Bank of America strategists wrote in a commentary. That “suggests another pullback is likely.”
The strategists said, “one signpost with a perfect track record [since 1935] is the Rule of 20.” During that period, the sum of the year-on-year consumer price index (CPI) change and the market’s trailing price-earnings (P-E) ratio was always lower than 20 at market bottoms.
Combining the 8.5% rise of consumer prices with the S&P 500’s recent trailing P-E ratio of 21.6, the sum stands at 30.1. That, of course, is far above the threshold of 20.