This blog post originally appeared on RealMoney Silver on July 22 at 7:51 a.m. EDT.
Chairman Bernanke hawkish and inconsistent in his testimony yesterday, as he pushed back the thought of stimulus while at the same time saying that economic uncertainty was growing. Equally surprising was that he said that the
had not completed a review of their alternative stimulus options.
In a perverse way, though, his economic warnings are bullish for the market, as he is typically among the last to recognize a problem (e.g., the subprime crisis). By the time he has, as he did with yesterday's recognition that "it is different this time," the markets are already in the advanced stages of accepting it.
Markets are a discounting mechanism. Rearview observations and, at times, observations regarding current circumstances/fundamentals (especially at important turning points such as the time of the stock market's
in March 2009) are often irrelevant in predicting future prices.
This was the core of my argument on
"Fast Money" last night, especially in my debate with my friend/buddy/pal, Brian Kelley.
As I argued last night, the forward P/E for the
(on a realistic corporate profits estimate) is now under 12x vs. an average over the past three decades of 15.5x and about 17x when inflation and interest rates are quiescent (as they are now).
Yes, the upside to stocks is capped -- I am using only 13x to get to my 1,150-1,160 S&P target -- by the ambiguity of the current soft economic patch and by the emergence of several nontraditional headwinds (higher marginal tax rates, costly regulation, and federal, state and local imbalances). But the wide gap between historic multiples and today's valuation seems to argue that the concerns are known and discounted.
The downside to stocks will be supported -- I am using 11x, which takes the S&P to the 1,025 level -- by the low probability of a double-dip and by growing evidence of a modest and shallow domestic economic expansion that is capable of sustaining itself.
On "Fast Money," I argued that we are in a growth slowdown, which is fairly typical when an inventory cycle matures. Meanwhile, financial conditions appear to be easing. Credit spreads have stopped widening, and liquidity spreads are also improving (hat tip to Mike Darda!):
- Two-year swap spreads, which typically presage a lower VIX and better corporate spreads, have narrowed since May.
- The Bloomberg Financial Conditions Index, which leads GDP by a quarter or so, is improving and, according to the lynx-eyed Mike Darda, is consistent with 2.5% real GDP growth.
- The euro is ripping higher.
- Three-month Libor has been flat to slightly down since May.
- Europe's economic plight might be overstated. For example, as I recently noted on The Edge, my exclusive trading diary on RealMoney Silver, Spanish bonds have risen while the S&P has swooned.
- Junk bond yields have dropped.
While I continue to see us in a range-bound market between 11x and 13x estimated 2011 S&P profits (1,025 to 1,150), there is risk to the upside of my stock market forecast for several reasons:
- Neither Bernanke's nor investors' expectations are elevated (as they were six months ago).
- Retail investors are underinvested and have not committed to domestic equity funds. Hedge funds have de-risked and are generally inactive. Who is left to sell?
- Should bonds begin to drop in price (rise in yield), a massive reallocation out of fixed income into equities could be triggered.
Man up, investors! The economic news has now been discounted in the markets. Chairman Bernanke told us so yesterday.
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.