This column originally appeared on Real Money Pro at 8:01 a.m. EDT on June 8.
NEW YORK (
) -- Where do I stand today?
Yesterday's late swoon and this morning's weakness in futures should not be unexpected after the
In terms of the major challenge, a beautiful and balanced deleveraging (occurring around the world) is a fine combination of monetary easing, austerity and restructuring debt that often leads to bumps along the way, similar to what we have experienced over the past month.
The challenge in the U.S. is that monetary policy has done almost all that it can do and the onus in now on fiscal policy, which will require a less divided and more cooperative Washington, D.C. Slow but positive growth in a muddle-through backdrop of +2% real GDP growth remains my baseline expectation.
The challenge in Europe is for central bankers and leaders to get back in front of the monetary curve (which they have now fallen behind).
Given China's rate cut, Spain's resolution being weeks away (the bank audits are going to be completed by month-end), the mid-June Greek election and the Fed's next (non-)decision being 12 days away, markets should tread water during most of June with limited upside or downside.
When I turned more optimistic in April, I expected more responsible leadership (in the U.S. and Europe), and I remain hopeful that we will get it. Frankly, over the past four or five weeks, I (and others) have been disappointed by our dysfunctional leaders, who too often place partisanship ahead of responsibility and necessity.
A bunch of subscribers have recently questioned why I am a bit more cautious with stock prices lower after having adopted a more aggressive investment stance in April at higher prices. It is because the facts have changed, and I was too anticipatory in the above expectations. A smooth deleveraging has proven to be more ephemeral, and the long tail of the last cycle has stayed prominent.
Time is of the essence. The market is temporarily losing the trust that it's trying to win back, as individual and institutional investors have continued to de-risk. We see this in continued outflows out of domestic equity funds, inflows into fixed-income funds and record unfavorable ratings for our politicians (Republicans and Democrats).
Regaining the trust (and flows) will now take more time than I previously thought.
For now, my fair market value calculation for the
(1455) is unchanged (about 10% upside), but I will be reassessing based on the policy responses and news over the next two weeks.
My base line case (scenario No. 4 with a 65% probability) is still in place, providing 16% upside to the S&P from current levels:
Scenario No. 4 -- Muddle Through (probability goes from 60% to 65%): The U.S. muddles through, with 1.5%-2.25% real GDP growth, and the European economies suffer a modest (but contained) business downturn. China's and India's economies grow in line relative to consensus forecasts. There is no further quantitative easing. Obama regains the White House, and the Republicans control Congress. The fiscal cliff is reduced by half (to $275 billion). S&P 500 profits for 2013 trend toward a range of $107-$109 per share as some modest margin slippage occurs (coincident with escalating inflationary pressures). Stocks, valued at 14.25x under this outcome, have 10% upside over the next nine months. S&P target is 1540.
If not, the second most likely outcome (scenario No. 3 with a 25% probability) suggests that the market is slightly overvalued:
Scenario No. 3 -- Below-Consensus Economic Growth (probability goes from 20% to 25%): The U.S. experiences a disappointing sub-1.5% real GDP growth rate, Europe experiences a medium-scale recession, and China's economic growth disappoints modestly relative to expectations. QE3 is initiated and has a modestly favorable impact on aggregate growth. Obama regains the presidency, and the Republicans control Congress. The fiscal cliff is reduced by less than half (to $275 billion-$350 billion). The S&P 500 profit forecasts for 2013 are reduced to levels slightly below 2012's results as corporations' pricing power is limited and profit margins are pressured, so S&P profit forecasts are cut back to below consensus of $98 to $100 per share. Stocks, valued at 13.0x under this outcome, have 8% downside risk over the next nine months. S&P target is 1290.
The bright side to all of this is that valuations are not demanding (particularly relative to inflation and interest rates) and the headwinds both in the U.S. and in Europe are now well known. This should insulate Mr. Market from any meaningful downside.
For now, either stock prices have to move lower to whet my appetite or substantive movement in U.S. fiscal policy and in European monetary policy must be delivered for me to get more invested.
It is that simple.
Doug Kass is the president of Seabreeze Partners Management Inc. Under no circumstances does this information represent a recommendation to buy, sell or hold any security.