This blog post originally appeared on RealMoney Silver on Dec. 8 at 8:01 a.m. EST.
I am a realist. We are in difficult and challenging times.
I have learned over the course of my investment career that the quest for delivering superior investment performance has grown more complicated, as it is accompanied by demands for permanent flexibility, a more balanced view and, usually, a less extreme portfolio construction. I am also of the belief that neither Polyannas nor Cassandras are stock market money makers; they are, more typically, only attention getters.
While I fully recognize that the road back to economic growth and stock market repair will not be orderly -- it will be filled with potholes and detours -- a
are now conspiring to improve the chances for business stability and for a recovery in the equity markets.
From my perch, some of these include:
- We are on the cusp of a more engaged leadership. It will take unconventional and bold remedies to solve unprecedented and complex economic and credit issues. It now appears that an engaged and new incoming Administration recognizes the severity of our economic problems, however, and the new team is composed of a group of outstanding and intellectual leaders with practical experience in overcoming past difficult periods of crisis. In my view, President-elect Obama's appointees form the basis for high-quality policy responses capable of addressing our uncertain economic future.
- Massive stimulation now appears on the way. A more ambitious and focused stimulus agenda is forthcoming, as a new Administration better understands the slope of the domestic economy's downturn. As such, a possible recovery can be forecast with better clarity and higher probabilities. By contrast, the markets remain in disbelief, as a possible buying climax in Treasuries and a likely selling climax in commodities (such as oil) seem to be signaling an extreme view that the economic spiral will never end. As the lynx-eyed Bob Farrell commented to me over the weekend, the recent 20-day rate of change in Treasury yields, which has fallen more than 30%, the fastest levels since 1980, is a classic indication of prevailing and extreme economic pessimism. Each time the rate of change has fallen more than 15%, yields have rallied hard, usually implying improved business conditions. Another manifestation of economic bearishness is seen in the price of crude oil, which dropped by over 70% from its 2008 high and, in only the past week, has dropped by more than 25%, the largest weekly drop since the 29% drop in 1991 when U.S. forces invaded Kuwait at the end of Desert Storm.
- The housing industry's problems are finally being addressed. As I have long argued, housing has been at the epicenter of the economy and credit market's woes. Fortunately, a combination of targeted and aggressive policy efforts aimed at reviving this beaten down sector of the economy, a marked reduction in home mortgage rates, better affordability and an extended period of low production of new homes (vis-à-vis population and household formation growth) argue that the balance between housing supply and demand might move closer in balance earlier than is now generally expected.
- We have reached an extreme level of negative investment sentiment. High bullish sentiment on fixed income is being matched by high bearish sentiment in stocks. According to Investors Intelligence, equity bulls now stand at only 23%, a 20-year low. By contrast, Market Vane's survey on Treasuries was at a remarkably high 89% bullish last week. Not surprisingly (considering the backdrop), investor expectations for the U.S. stock market have been ratcheted down week after week. Hedge fund net invested positions are at lowest levels not seen since 2002, the disintermediation of mutual funds is now reflected in record-level individual cash positions, and the flight out of hedge funds has continued apace, but these are rearview conditions. During past cyclical market lows and economic troughs, fear, panic and sizeable job losses have been essential ingredients to recovery.
- Stocks have shown early signs of reacting more positively to bad news. The NBER's rearview recognition of a one-year-old recession should encourage investors. Stocks anticipate fundamentals, and, as I have previously documented, stocks typically mount a 25% rise before recession's end. Already a number of stocks have moved smartly higher in the face of negative news, especially in sectors that typically presage improvement in credit and of the overall stock market. In banking, JPMorgan Chase (JPM) - Get Report; in REITs, Vornado Realty Trust (VNO) - Get Report, Boston Properties (BXP) - Get Report and SL Green Realty (SLG) - Get Report; and in asset managers, AllianceBernstein (AB) - Get Report and T. Rowe Price (TROW) - Get Report.
- Energy and commodities prices have plummeted. While carrying negative implications for the current economic downturn, the remarkable drop in "stuff" also holds positive implications for the consumer (serving as a tax cut) and for corporate profit margins.
- The marginal buyer has emerged. I have long been concerned about where marginal demand for stocks would arise. The answer might be the hedge fund industry, which is poorly positioned for an advancing market at present, as the market's extreme volatility, large investment losses and the specter of redemptions have resulted in a mass exodus of hedge fund cash to the sidelines.
- Market volatility might soon diminish. Looking into early 2009, some stability could return to the hedge fund community, as redemptions slow down, some large hedge funds fail (and close their doors at year-end), money is re-circulated to other investment managers and the rate of decline in economic activity moderates (as the stimulus takes hold).
With so many extreme sentiment readings (and a steepening in the price and yield declines) in commodities and fixed income, coupled with more substantive/coherent policy measures (and a more engaged leadership) and a market that has begun to respond more positively to bad news, an important change in stock market conditions could be imminent just when most investors have turned to the sidelines.
Color me more bullish, as it is my view that, in the fullness of time, policy, sentiment and value will trump corporate profit and credit issues.
Doug Kass writes daily for
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Know What You Own:
JPMorgan Chase operates in the money center banks industry, and another stock in its field is
. For more on the value of knowing what you own, visit TheStreet.com's
At the time of publication, Kass and/or his funds were long JPMorgan Chase, Vornado Realty Trust, Boston Properties, SL Green Realty, AllianceBernstein and T. Rowe Price, 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.