This blog post originally appeared on RealMoney Silver on June 30 at 7:55 a.m. EDT.
There is no observed improvement in the emotional stability of the average investor, notwithstanding dramatic advances in financial literacy or in the sophistication of computer software. The investor of the 1990s is probably no less prone to excitability and self-delusion than the investor of the 1920s. Paul McRae Montgomery... has made a lifelong study of the role of perception in the financial markets. There is the logical and calculating part of the human mind, Montgomery has observed , but there is also the emotional and impulsive region. Each plays its role in the supposedly cold-blooded calculations of buying and selling stocks and bonds. To suppose that the value of a common stock is determined purely by a corporation's earnings discounted by the relevant interest rate and adjusted for the marginal tax rate is to forget that people have burned witches, gone to war on a whim, risen to the defense of Joseph Stalin, and believed Orson Welles when he told them over the radio that the Martians had landed. Investors are prone to be bullish at the top of the market when prices are high, and bearish at the bottom when prices are low. Like war, speculation is a social activity. It is carried on by groups. -- James Grant, Minding Mr. Market: Ten Years on Wall Street With Grant's Interest Rate Observer
As I have
repeatedly, all is not rosy -- far from it! My intention is not to be a Pollyanna; I recognize the current soft patch in domestic economic activity. Housing, in particular, remains sluggish and confidence subdued. Moreover, there exists numerous P/E multiple deflators and nontraditional headwinds to growth. The following factors don't necessarily prevent an extended bull market, but they most certainly have deflated P/E multiples -- the
now trades at only 11.5x 2011 forecasts -- and have put a cap on the market's upside potential:
- rising taxes;
- fiscal imbalances in federal, state and local governments;
- the absence of drivers to replace the prior cycle's strength in residential and nonresidential construction;
- the long tail of the last credit cycle (Greece, Portugal, Spain, etc.); and
- inept and partisan politics.
While there are headwinds aplenty (some gale-force), they are now mostly well-known and arguably have been incorporated in more measured market and economic expectations, as the notion that "it's different this time" has become an accepted view.
With benign inflation and near-historic lows in interest rates and with most measures of business activity still signaling moderate growth ahead (as Jim Grant wrote in
Minding Mr. Market
), to some degree, it can now be argued that the equity market is traveling the path of fear rather than the path of fundamentals, as emotions and a crisis in confidence have overwhelmed good corporate profits growth, strong productivity gains and rock-solid corporate balance sheets.
Importantly, the S&P now provides an 8.7% earnings yield (the inverse of the P/E ratio), which seems very attractive against a 2.95% return on the 10-year U.S. note and no return on cash. That differential between the S&P's earnings yield and other interest rates is among the widest in decades.
Jim Grant reminds us that investors are typically greedy when they should be fearful (e.g., spring 2008 and two months ago in late April 2010), and perhaps now, as was the case at the
in March 2009, they should consider being more greedy when others are growing more fearful.
In "Free at Last," I
that the market's descent was creating more long investment opportunities than seen in six to eight 8 months, and I suggested that any further retreat in stock prices should be bought.
Over the past few days, many individual equities have approached or are approaching increasingly attractive entry points as fear has overcome many market participants.
As one of my most savvy acquaintances in the hedge fund community suggested to me last night, Mr. Market himself is looking cheap. According to this friend, the market, in the aggregate, is currently discounting a double-dip and is pricing in 2011 S&P earnings at about 25% less than consensus.
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.