This blog post originally appeared on RealMoney Silver on June 24 at 8:44 a.m. EDT.
"Free at last; free at last; thank God Almighty, we are free at last." -- Martin Luther King, Jr.
Pardon the hyperbole, but I have been waiting for this moment since last fall.
Growing Acceptance of a Shallow and Lumpy Recovery
Even after I suggested in March 2009 that we were approaching a
, I have always warned that the economic cycle in 2009-2011 would be inconsistent and lumpy, difficult for both corporate managers (who had limited pricing power) and investment managers (who would be challenged by a range-bound and trendless market) to navigate.
The constant thread in my view over the past two years was that, at times, it would appear to many (this year and next) that we were out of the recession, and at times it would appear that we are embarking on an economic double-dip. By contrast, the (growing and almost universal) consensus was for consistent and self-sustaining growth (steady at 3.5% for 2010-2011) and unrealistic stock market expectations -- it was only three of four months ago that leading strategists consistently paraded on
and expressed the view of a strong first half in equities and an eventual price target of 1,300 for the
in 2010, nearly 20% above the current price.
As retail spending faded, housing disappointed, the growth in employment remained stubbornly slow, fears of euro zone economic weakness intensified and confidence in our government disappeared, many are now finally adopting my scenario of lumpy but positively trending shallow growth.
When Bulls Turn Bears, Take Notice
Stated simply, the economic soft patch we are now in has reduced the ranks of economic optimists, which is a good thing from a market standpoint. The previously heightened economic and market expectations are now more realistic and, in many corners, downright pessimistic. Even my pal,
, has serious economic reservations today.
Nary a Bull in CNBC's House
When stocks moved ever higher during the winter and skepticism was nowhere to be seen,
had a constant procession of uber-bullish commentators -- nary a negative view was expressed for months. By contrast, recently, and most significantly this morning, the opposite expressions of view have been advanced -- since 6:00 a.m. EDT, five consecutive bears have appeared. And as I write today's opening missive,
Cassandra-like utterances can be heard, and none of my pals "Squawk Box" pals, Joe, Becky or Carl (who are normally skeptical of extreme views), appear to be questioning his "wisdom"!
Stocks Often Diverge With the Economy
As I have
recently, the economy and the markets are two different animals. Corporate profits grew at a healthy pace from the bowels of 2001 until early 2008, yet stocks barely budged. Mr. Market, wiser than even his years, sensed the credit calamity of 2008-2009.
Importantly, the foundation for a sustained but historically shallow economic recovery appears to be a reasonable baseline expectation. The cracks that led to the
, though costly, have been generally fixed.
As a sharp observer and friend mentioned in an email to me this morning, the myth of a double-dip dominates reality -- for example, the U.S. is out with healthy manufacturing reports, Barclay's notes this morning that European industrial orders are consistent with an ongoing recovery, and China appears to be achieving a soft landing).
The Market's Valuation Is Becoming More Attractive
The prospect of an upward move in equities is also becoming reasonably solid. As an asset class, stocks were never stretched to the degree of other classes -- commodities, private equity, residential and nonresidential real estate were all lifted to multiple sigma events. The S&P will earn approximately $90 a share in 2011, so U.S. stocks sell at only 12 times vs. a multidecade average of 15.3 times and at over 17 times during comparable periods of quiescent inflation and interest rates.
I remain a realist.
As I wrote in "
," some discount from historic ratios seems appropriate given the reality that it is different this time. Most notably, taxes are rising, fiscal imbalances are large and unprecedented, there is an absence of drivers to replace the prior cycle's strength in residential and nonresidential construction, the tail of the last credit cycle remains long during the current deleveraging environment, and we have remarkably inept and partisan politics.
These factors, now increasingly accepted by the consensus, will serve to cap the upside of equities but not preclude a healthy advance as, with an 8.4% earnings yield against a 3.15% return on the 10-year U.S. note, the differential is among the widest in decades.
Who Is Left to Sell?
In speculation, interestingly enough, contrary-mindedness is often a virtue. A layman might suppose that profits lie with the majority. Because the mass of people have the weight of the money, he might imagine that the crowd would tend to be on the winning side of things. Not for long, in my experience. If the majority confidently knows something, that one thing is probably already reflected in the structure of prices, and the market is vulnerable to a surprise. Markets are moved by the unexpected and the unexpected is what the crowd isn't anticipating. The financial future may be imagined, but it can never be positively known. What people know is the past and present, and they often project the familiar out into the unknown, with unsatisfying results -- Jim Grant, Minding Mr. Market: Ten Years on Wall Street With Grant's Interest Rate Observer
With optimism on the wane, retail investors lowering or exiting their positions in U.S. equities and hedge funds having de-risked, no one can say that investors' animal spirits are elevated.
Contrast this deflated outlook for U.S. stocks with the enthusiasm for fixed-income instruments and with everyone's favorite, gold.
"Faith is taking the first step even when you don't see the whole staircase." -- Martin Luther King, Jr.
In the face of reduced expectations, moderate (but upwardly sloping) economic growth and low interest rates (and inflation), I believe that we are approaching or at a point in time in which stocks could soon provide more generous returns.
As I have written,
We Will Never Know the Exact Time to Buy
Make no mistake, though, there still remains a number of possible economic outcomes, some that are less than benign. And, as Jim Grant reminded us 17 years ago, one of the many ways to be wrong about the markets is through excessive farsightedness (also "through pride, ignorance, bad luck, impatience, imagination and sophistry"). So there is nothing that says that the S&P 500 at 1,090 is the exact time to expand net long exposure. The 1,050 to 1,090 area (the lower end being only 11.5 times 2011 my corporate profits forecast) has my attention, and it is my current intention to accumulate longs if we move toward the lower end of that range (where the market has already had several tests).
This is not a clarion call to buy stocks. I have been market-neutral to net short for many months now, and I come to today's view and conclusion from an underinvested stance.
But, when I weigh the positives and negatives, for the time being, or at least through the remainder of 2010, stocks might be locked in an S&P range of 1,050 to 1,180, implying 11.5 times at the low end and 13.1 times at the high end off next year's $90 a share S&P forecast. The upper bound looks attainable later in the year and could set the stage for further progress in 2011 if the economic soft patch straightens itself out and the fears of a double-dip diminish (my expectation, too).
As a long-term value investor who embraces the opportunity inherent in lower stock prices, I am certainly getting my opportunity now. For the month of June and year-to-date, the S&P 500 is down by nearly 1% and 3%, respectively.
Be (More) Greedy When Others Are Fearful
Market bottoms are made coincident with bad news, while market tops are made in the face of good news. Neuberger Berman's founder Roy Neuberger, still an active investor despite his 105-plus years, once told me to buy at the sound of cannons (and sell at the sound of trumpets).
Roy's words ring true to me this morning, and the markets might, sooner than later, become fun again.
We will then be free at last.
Color me more bullish.
Doug Kass writes daily for
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Doug Kass is the general partner Seabreeze Partners Long/Short LP and Seabreeze Partners Long/Short Offshore LP. Under no circumstances does this information represent a recommendation to buy, sell or hold any security.