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This blog post originally appeared on
on March 9 at 8:01 a.m. EDT.
Most of the time, common stocks are subject to irrational and excessive price fluctuations in both directions as the consequence of the ingrained tendency of most people to speculate or gamble ... to give way to hope, fear and greed.
-- Benjamin Graham
I remain firmly committed to the notion that we are in
and that the world equity markets are now tracing an important bottom.
For the second consecutive week on
, I reiterated my
more optimistic message
Last night on
's "Fast Money," Dylan Ratigan started
with a quote from
The Intelligent Investor
's Benjamin Graham that underscored a still expensive market. Essentially, Yale's Dr. Robert Shiller made the case that applying Graham's view that a 10-year period of smoothed corporate profits took out distortions and concluded that the
index trades at 13 times compared to a multiple under 10 times at the bottom of the last three recessions, suggesting that U.S. stocks were about 25% overvalued.
My response was that the investment mosaic has grown a lot more complicated and a 10-year period provides far too few empirical data points, and it is too linear to use only one model, as Shiller suggests.
I prefer to look at multiple models. As it relates to Graham's observation, I would prefer to look at normalized earnings (12% ROE) on the S&P's book value of $560 -- or EPS of about $67 a share. Over a lengthier and more statistically significant period -- seven decades -- stocks tended to trade at 15 times normalized S&P profits (S&P equivalent of 1005) and bottomed at between 11.5 times and 12.0 times (S&P equivalent of 787). We are now at only 685 of the S&P, or at a 10 times multiple, so rather than being overvalued -- as
Benjamin Graham/Robert Shiller
might opine -- stocks have overshot the downside valuation that has historically provided support and now appear undervalued.
In the "Fast Money" segment, I detailed multiple valuation models I use to assess the current value of U.S. stocks, all of which make clear that equities have incorporated a lot of bad news and are undervalued both absolutely and relative to fixed income:
It is also important to recognize the importance of the value of stocks relative to fixed income and inflation, as Zachary Karabell
. I do:
- The risk premium -- the market's earnings yield less the risk-free rate of return -- is substantially above the long-term average reading.
- Valuations are low vis-a-vis a decelerating (and near zero) rate of inflation; indeed, the current market multiple is consistent with a 6% rate of inflation.
- A record percentage of companies have dividend yields that are greater than the yield on the 10-year U.S. note. At over 50% of the companies, that is nearly 5 times higher than in the peak of 2002 and compares against only 5% on average over the last 30 years.
Not only are there few who believe we are making a bottom, but there is virtually no one who thinks a sustainable market rally is possible.
I wanted to end this morning's missive by reclaiming some comments I made on
Chicken Little has regained credibility -- my Twitter account beeps more than five times a day to report where Nouriel "Dr. Doom" Roubini is appearing and speaking.
Nearly everyone can explain why the market has gone down and why it is unlikely to rebound, but hardly anyone can find a reason to rally. The business and general media, in marked contrast to the past, almost refuse to consider factors that can contribute to a sustained advance in stock prices. (It is even hard to find a bull on "The Kudlow Report" these days -- in marked contrast to the cheerleading that existed in years past.)
It is important to recognize that only a handful anticipated the current credit and economic travail, nevertheless, the alacrity and confidence of a dire outcome in the land of the Chicken Littles is something for me to behold.
Three years ago, cash was not king, the buying power of private equity dominated the investment landscape, and no takeover (regardless of size) was impossible. Endowments, pension plans, banks and hedge funds jumped headlong into the leveraged world of private equity.
Even two years ago, mutual and hedge funds were enthusiastically invested in equities (especially of a materials, commodities and energy kind) as the newest paradigm of economic decoupling gained credence.
Today, cash (and liquidity) is back on the throne as king, as the great unwind of debt and the liquidation of overlevered investments gains momentum as the hedge fund industry implodes further.
Of course, the moral of yesterday's "In the Land of Chicken Little" story is not to believe everything you are told.
Take the advice of the Johnny-come-lately Chicken Littles if you will, but trust me, they will not anticipate recovery, nor will they (like the cagey fox) participate in feasting on the developing and unprecedented values.
Attractive valuations, a negative sentiment extreme and early signs (and expectations) of economic stabilization are moving closer to reality.
The sky is not falling as value is on our doorstep and dinner is being served!
How you can survive -- and even prosper -- in a rocky midyear market? Get the "best ideas to make real money" from Jim Cramer, Doug Kass, Helene Meisler and other RealMoney experts at our May 2 Investment Conference. Learn more here
At the time of publication, Kass 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 Long/Short LP.