Doug Kass Bearish on Equities

This comes via TheStreet.com and Doug Kass, a noted market strategist:

Many strategists (both bullish and bearish) assume that a fair value P/E multiple — based on interest rates and inflation — rests at about 15.5 times. Averaging the 2009 and 2010 S&P consensus forecasts produces a melded $67.50 S&P EPS, a year-end target of 1045 and a mid-2010 S&P target of 1130 on an EPS of $73 a share — against the current S&P level of 1043.

Bearish strategists such as David Rosenberg (this weekend’s Barron’s interview) believe the current S&P level is discounting a 40% increase in 2010 earnings over 2009, but the consensus believes (above) that about 10% growth is being discounted.

Bearish strategists (again) like Rosie expect real GDP growth of about 1% to 2% next year, but the consensus now anticipates 3% to 3.5% growth in 2010.

As Kass later points out, the anticipated earnings growth fuelling this rally must be predicated on continued leverage. The present multiple and earnings growth has come from cost-cutting which lowers employment and income – and, thus, aggregate demand in the absence of more leverage (See Tom Toles’ not-so-funny depiction of this via Prieur du Plessis).

According to Kass, other headwinds include poor commercial real estate fortunes, lower local government spending, and higher taxes. All of this makes the market rally seem more bear market rally than secular bull.

And I can think of no secular bull markets that began with a 40% surge in earnings multiples.

More here.

Comments

[CautiousInv...:]

I'm running short on time so I will share with SA readers some insights offered by David Rosenberg that compliment those offered by the author and Doug Kass. From Rosenberg:

Okay, let's get this straight. We are now being told by the pundits that the reason why Mr. Market is managing to so readily shrug off adverse data is because Mr. Market is discounting “normalized” 2011 earnings of $80. That is behind the latest round of S&P 500 estimates of 1,200. After a momentous 50%+ surge from the lows, anything is certainly possible. But let's see if it makes sense. First, with household net worth down $14 trillion, employment down 7 million since the start of the recession and consumer credit down $110 billion from last year's peak, it would seem to us as though there are too many gaping holes to believe we are going to be seeing anything remotely close to “normalized” earnings any time soon. But even if that were the case, it would suggest that the market is trading near a 12x two-year forward multiple. Go back 80 years worth of data, and the mean two-year forward multiple is 7x. Too rich for our liking.

FIVE POINTS WORTH MAKING ON THE MARKETS, EARNINGS AND THE ECONOMY

1. This remains a hope-based rally in the equity markets (with strong technicals). What we are seeing transpire is without precedent - the magnitude of the employment slide versus the magnitude of the market advance.

2. Companies have not really been beating their earnings estimates - only the very final estimates heading into the reporting quarter.

3. Valuation is a poor timing device but even on “normalized” trailing 10-year earnings, the S&P 500 is trading near 18x, which is now above the historical average of 16x.

4. All the growth we are seeing globally this year is due to fiscal stimulus.

5. While Mr. Market may be pricing in a fine future for the U.S., but when the 3-month Treasury-bill yield is 13bps north of zero, you know that there are still substantial fundamental imbalances that need to be worked through.

Sep 15 07:43 AM

[buyitcheap:]

Here here! To the author and post above.

Sep 15 07:44 AM

[Avooch:]

I track a handful of industrial enterprises closely and can only find one US company (Emerson Electric) which is even close to being at a level which is prudent to buy.

I just posted an analysis of Regal-Beliot (RBC) which is selling North of $45, I came up with $31 as 'reasonable' risk.

-------------------------
Don't Get Massacred !

gudovac1941.blogspot.com/

Sep 15 08:07 AM

[Daryan:]

How long does one have to be so completely wrong, not so much Kass since his March call was prudent, but certainly Rosenberg, that they have to finally admit it. The market is telling you what is going to come, pundits and Rosenberg be damned. Feel free to keep on doubting, I'll keep on making money trading to the long side until the market indeed tells me I am wrong and I switch back to being net short.

Sep 15 09:33 AM

[enigmaman:]

Bottom line IMO is a complete and utter disconnect between what the Government, Wall Street and main street think are the answers.

Big government thinks bigger government and higher taxes is the answer
Main street wants smaller government and less taxes
Wall Street doesnt care because they will win either way

For the US to pull out of this economic morass anytime soon all three need to be like minded, unfortunately we are all pulling in different directions which means more pain and less gain.

Sep 15 09:58 AM

[David Van K...:]

What was the market at when Kass called his last top? I've lost track.

Sep 15 10:36 AM

[hoover:]

I have owned and operated a small business in a major city for 25 years. I would only say that looking UP through the economy from main street, like I view it, is far different from looking DOWN through the economy from Wall Street. I don't believe more money for banking conglomerates, more large corporate mergers, more glowing stock market BS, more loans for business large and small, more leverage, more exotic financial instruments, or magic Wall Street tricks are going to fix anything. I would suggest the financial gurus start looking at the economy from the botom up, instead of the top down, and be prepared for a major shock.

Sep 15 11:06 AM

[bricki:]

Kass was supposedly shorting the S&P500 at 1030.

While I am skeptical I'm not THAT skeptical. We could easily see 1200 in Jan before harsh reality sets in.

Sep 15 11:11 AM

[eternitus:]

What happens when you adjust trailing 10-year earnings for inflation and normalize for interest rates? Looking at the non-financial sector, I bet that you'll find that the market's current valuation multiple does not require much earnings growth at all.

Gets a little dicey with the financials...

Sep 15 11:18 AM

[TCK:]

When I went to my last job interview for fast food position, I was discussing the finer points of economics, GDP, P/E ratios, etc with some of the other 1000 plus applicants.

While the discourse did not contain any Nobel prize winning theories, most agreed the economy SUCKS right now !

Sep 15 11:31 AM

[Jeff Diercks:]

Psychology has a lot to do with market moves. If we can get by the historically tough months of September/October, you could see the S&P 500 hit 1200 as seasonally positive patterns emerge (this also is the target set by the break of the inverse head and shoulder pattern on the S&P 500).

I agree that this move would be crazy relative to S&P 500 forward earnings, but market moves tend to go much farther than anyone would ever expect.

Next year however I will wager will not be a pretty year for the market averages.

Sep 15 12:53 PM

[Mad Hedge F...:]

ttn The dinosaurs of the market, like myself, are collectively being struck by the similarity of the current stock market and that of September 1987, just before the one day, 25% plunge in the Dow. That was when I tied to buy stock with the index down 300 from a payphone in Paris, only to have the trader at Morgan Stanley burst into tears and smash the phone down on the desk (remember that David G.?). My new guru is Gluskin Sheff’s strategist David Rosenberg, who says that stocks have already discounted two years of recovery and now carry a lot of risk. It is priced for 40% EPS growth and a “V” shaped recovery, which we have zero chance of getting. GDP this year will come in at negative 2.5%, and will claw back a listless 1-2% rate in 2010. Stocks are discounting a 4% GDP growth, compared to only 2% for bonds, so he’d much rather own those. With a deflation rate of minus 2% and high yield returns of 12%, junk now offers a 14% inflation adjusted yield, not bad. The secular 25 year bull market in credit expansion is over. Rent still accounts for a third of the CPI, and they are falling for the first time in 17 years. Sure, we’ll see ephemeral sugar highs like those for cash-for-clunkers and the tax credit for first time home buyers. But at best, it will only add up to a series of small “W”’s, or what I refer to the as the “square root” shaped recovery. With the price of everything stretched, you better start reeling in some of that risk.

Sep 15 02:21 PM

[Henry L. Me...:]

Still the same old Seeking Alpha crowd. Missing out on an incredible bull run by nay-saying the market.

Sep 15 04:26 PM

[Archman Inv...:]

<<Still the same old Seeking Alpha crowd. Missing out on an incredible bull run by nay-saying the market.>>

I can only speak for myself. Yes, I think the market is a joke. Yes I think the market is completely manipulated. Do I think the market should be at 750 on the S & P 500? Yes.

It is a shame that there are people out there who think just because I know what is really going on, that somehow I missed the run up from S & P 670. Again I am only speaking for myself. Thankfully, my portfolio is where it should be: at 2009 levels. Thankfully, for the past 15 years, I have had only 2 losing years: 2002, down 3%, and 2008 down 15%.

But think of the average American. Their portfolio is at 1998 levels. And that is assuming they didn't try to catch any of the falling financial knives like C or AIG, or FNM & FRE on the way down, which many people did. Even with the "rebound" in stocks the majority of average American portfolio is only a fraction of what it used to be, and some are completely out of the market altogether not because they lost money. No, because they lost it all.

I would be cautious to assume that just because people like myself see the market for what it really is, and get our information from sources other than CNBC, and who are negative on the phony market, do not assume that we have "missed out" on anything.

As a matter of fact, I know for a fact, that at some point in the near or mid term future, Americans once again will get their clocks cleaned and from their place on the floor, look up and wonder how people like myself manage to create real, sustainable, consistent long term wealth over time.

compdivplan.com

Sep 15 04:46 PM

[enigmaman:]

That you invest and make money should be reward enough, make your money in the dark, why do you want to call us out on it, what your doing is working, great!, be happy, you climb the wall of worry build by the nay sayers, or maybe your just FOS


On Sep 15 04:26 PM Henry L. Mencken wrote:

> Still the same old Seeking Alpha crowd. Missing out on an incredible
> bull run by nay-saying the market.

Sep 15 06:39 PM

[ebworthen:]

SHHHH!

We're busy getting all the retirees and investors to put their chips back on the craps table while we gradually sell off here at the top.

How else are we going to pay for the second wave of collapses due to over-leveraged commercial real estate and prime loans defaulting?

We need things to go up more on speculation and hope and convincing people it's 1983 all over again even though we have a tax and spend left leaning President and 40% less manufacturing and 30% more people dependent on the government. Just a little more so we can get all that juicy cash on the sidelines back in to make the banks solvent again.

Sincerely,
Timothy, Ben, Wall Street, and Elected Officials

Sep 16 01:52 AM

[ebworthen:]

I'm happy to miss out on an unethical leveraging of a cotton candy market via taxpayers.

And...I don't have to lose sleep at night waiting for the inevitable correction.

Fool me once shame on you, fool me twice shame on me.


On Sep 15 04:26 PM Henry L. Mencken wrote:

> Still the same old Seeking Alpha crowd. Missing out on an incredible
> bull run by nay-saying the market.

Sep 16 01:54 AM

[DonFurio:]

At the end of the day, people still need to make back some of their paper losses. While people like myself continued to buy throughout the past year, many did not, and cannot make up for their shortfall by saving cash alone, they pretty much need to invest. Also, the earnings estimates for 2009 have had to be steadily increased as people realized that they were unrealistically low. D. Kass is a perma-bear and he runs his hedge fund very well, but by his nature he is looking for short opportunities. He may be right short term, but while calling a 10% drop might be great for him, for most people it is a good opportunity to further buy.

The recession has forced companies to really look at how they operate and see what structural improvements can/could be made. How come there aren't more articles about how the unemployment rate for college educated is way better than those who are not, and that when the economy recovers, they have a much higher chance of being hired, of course I’m talking about degrees with real majors, not like a Philosophy major.

I feel like the main objective of SA these days is to try to constantly bash the market. The sooner you idiots realize that the long term trend of the market is up, maybe you will stop the whining. I’m ok with analyzing company/gov’t decisions and how that impacts the market, but it seems like it’s always the negative. If you go back to many of the bearish posters now, they were posting the same bearish stuff when the dow was at 7,000, and have called the entire rally a suckers rally. I also read/hear all these arguments about how the market is rigged and why not to invest for moral reasons. I’m sure some of the same people cheat on their wives, are not good parents, etc. I’m clearly not trying to say that everyone is like that, because they’re not, my point though is that if you truly are a risk averse person and that even paper losses make you feel uneasy, than yes, stay out of the market. But to invest in the market because some people will also make money from stock price appreciation is just dumb. Of course there are always risks to investing, but there is just about every type of investment opportunity available depending on your risk tolerance and what you believe will happen in real estate, equities, corporate bonds, munis, etc, but you either have to do the work yourself and take responsibility for your decision whether you are right or wrong, or pay for a broker and understand that he may end up being right or wrong, but you made the decision to agree to what he suggested. It’s always easier to whine and play the blame game, but rarely will that ever get you paid.

Sep 16 10:10 AM

[Deepv:]

Buffet is buying stocks but you jokers are talking about overvaluation even as we sit at post 9/11 prices for mny blue chips. Cash is not worth very much at 0% risk free rate. What don't you understand? You guys are sitting in front of an impending emerging markets boom obsessing about the US consumer. You just had a bear market that begain in 2000 and relapsed big times in 2008/09. Get over it and start investing.

Sep 16 10:35 AM

[Deepv:]

most pseudo skilled articulate posters on seeking alpha have been unequivocally bearish through the rally. The rally will end once these guys capituate, just as the bear phase came to and end when even the most staunch bulls capitulated or even apologized for owning stocks.

Sep 16 02:46 PM