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"Stay committed to your decisions, but stay flexible in your approach."
--Tom Robbins

This is a tough call for me to make because I believe the world's economy and capital markets face significant challenges. But, increasingly, many of those concerns have been recognized, and some of my shorts have reached my targeted price objectives. That said, in a roller coaster market that has no memory from day to day, successfully gaming 5% moves (or so) becomes a necessary ingredient to creating alpha (excess returns). This will be particularly true in the generally low-return setting for equities that I envision over the next year or two.

In summary, the ingredients for a market rally are now falling into place. Whether it occurs today, tomorrow or in the next few weeks, I think it is coming, albeit at far lower levels than

Barton Biggs

had predicted recently on


"Fast Money."

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I would note that while the anticipated recovery in share prices (amidst this week's gloomy headlines) could be far more brisk than the growing ursine crowd expects, the economy and financial system face broad challenges that will likely limit the rally in scope and duration. A relatively choppy and uncertain picture should unfold after the anticipated year-end rally.

A short-term rally could now occur for some of the following reasons.

    Economic: Even the most optimistic bulls now acknowledge the likelihood of a consumer-led slowdown and the likelihood that housing will not recover for several more years, two themes I have emphasized over the last year. It will now come as no surprise to most, and it might be partially discounted. Subprime Storm: The credit event, until recently (like housing's depression), has been ignored by the steadfastly bullish crowd. No more. Media coverage and investors' preoccupation of this issue is now elevated. I am looking for a sign of relief on the part of investors after Goldman Sachs (GS) - Get Goldman Sachs Group Inc. (The) Report, Merrill Lynch (MER) and Morgan Stanley (MS) - Get Morgan Stanley Report have quantified their fourth-quarter credit writedowns and their exposure. Frankly, the exposure levels are less than I anticipated. In the badly beaten down financials -- where I see the reverse of momentum compared to anointed ones Apple (AAPL) - Get Apple Inc. Report, Research In Motion (RIMM) , Google (GOOG) - Get Alphabet Inc. Report, Baidu (BIDU) - Get Baidu Inc. 百度 Report, etc. -- some have actually done a relatively reasonable job in managing and taking down that exposure, though few have been unscathed. Importantly, the Administration finally appears to get the severity of the subprime crisis, and the odds of an organized (and sensible) government response (in the form of a fiscal Marshall Plan to save homeowners) will be roundly appreciated by the markets. Sentiment: I judge sentiment more on what I see hedge funds doing (admittedly a thin-reed indicator), through my personal contacts, rather than sentiment polls of writers or individual investors. And over the last week, there is little question in my mind that shorting/hedging is dramatically on the rise. Some of those shorts are being executed in stocks/sectors that have experienced dramatic near-term drops, potentially setting the stage for a violent rally from oversold levels. Stated simply, there appears to be too much piling on based on obviously disappointing headlines (that many of us anticipated). My experience, however, has been that when the headlines are this bad, and with sentiment from my cabal at nearly the polar opposite than when stocks hit their highs two months ago, the market typically has done a pretty good job of discounting. (Supportive of my anecdotal observations on rising skepticism is the latest ISI Hedge Fund Survey, which indicates hedge fund long exposure is now at the lowest level since 2004.) Takeover Activity: While private-equity firms have been quiescent (for obvious reasons), I expect to see a flurry of opportunistic corporate takeovers (perhaps even some high profile ones!) aimed at attempting to take advantage of the recent market drubbing. Year-End Seasonality: The latter part of the year is usually seasonally strong. According to Stock Traders Almanac, since 1950, the DJIA and S&P 500 have averaged a 1.7% gain. The Dow has been up in 40 years and down in only 16 years while the S&P has risen in 42 years and dropped in only 14 years. The gain in the Nasdaq and Russell 2000 are even better, averaging 2.0% increases since 1971 and 2.6% gains since 1979. These are historically powerful seasonal tailwinds that might even be exaggerated in 2007 as hedge funds, thirsty for performance, go all in. Political: Surprisingly, the Republicans are beginning to catch up to the Democrats in the 2008 Presidential polls. This could be an underappreciated and constructive (at least for stocks) factor. As reported by RealClearPolitics, Rudy Giuliani (the likely Republican candidate) is actually now ahead in two of the 11 national head-to-head polls; in the others, Hillary Clinton is holding on to a diminishing lead. This is shocking to me, quite frankly, as I anticipated another Democratic tsunami. A further shrinkage in the Democratic lead will be viewed as a positive, as the trend toward trade protectionism and higher corporate and individual taxes may be less clear than I previously thought.

In conclusion, I stressed


this week, and my intention is to practice what I preach and to avoid the dogma that some too often attribute to my market views. Nevertheless, I should emphasize that I am hardly a long-term bull. That couldn't be further from my view.

At the time of publication, Kass and/or his funds had no positions in the stocks mentioned, although holdings can change at any time.

Doug Kass is founder and president of Seabreeze Partners Management, Inc., and the general partner and investment manager of Seabreeze Partners Short LP and Seabreeze Partners Short Offshore Fund, Ltd.