Kass: Fear Is the Rational Buyer's Friend

Doug Kass

05/20/10 - 02:00 PM EDT

Coincident with lower share prices around the world, the business media this week have been inundated by negativity on the part of nearly every talking head. This comes as we are told by nearly every heavyweight during a high-profile hedge fund conference in Las Vegas that "risk is coming off," and all of them basically said the same thing to CNBC's David Faber in a series of interviews yesterday.
What is even more surprising is that many of the aforementioned observers and practitioners are so certain in their views. (I wonder at the certainty in an uncertain world, but that is a topic for an entirely different conversation!) This sort of glibness was in place by some of the same people when the S&P 500 recently rose above 1,200, but at that time, they were nearly all bullish.
The negativity of groupthink that exists today was best displayed last night on "Fast Money," when one of the commentators (a friend of mine) even apologized for being bullish!
I know most of the negatives -- I have been writing about the nontradtional headwinds for several months.
High on my list has been the long tail and aftershock of a cycle characterized by the egregious use of debt and credit. Dubai, Greece, Spain and Portugal are the residue of that cycle, but it is also likely the end, not the beginning, of the consequences. The IMF/E.U. financing packages aimed at stemming the contagion are bold, and they have been treated as negatively as the Federal Reserve and Treasury's programs to stem the carnage in the U.S. banking industry and the swift 2008 downturn in the domestic economy. Moreover, the associated austerity measures over there, if enacted, would likely improve the intermediate-term outlook for the affected economies and capital markets.
Also on my list is populist policy (leading to generally increased regulation such as bank and financial reform and higher taxes), which is an outgrowth of a public outcry that reflects the perception of a growing schism between the haves and the have-nots. It, too, is growth-deflating. But, that policy and its ramifications are well known and, quite possibly, serve the public good in the long run.
As stocks drift lower, skepticism ascends and shorts mount up, fear should be seen as the friend of the rational investor, and many stocks that I follow are approaching or are already at attractive price levels.
While most are now fearful, especially those who base their investment decisions on price momentum, I view individual stock opportunities on a fundamental basis, and based on my company contacts and channel checks, the domestic expansion is alive and well. It is interesting to note that the U.S. real private economy does benefit somewhat from slowing developed world (European) growth in the form of lower interest rates and lower commodity prices (especially of an energy kind).
I still have issues regarding a self-sustaining domestic expansion, and I understand that many of these factors limit market and economic upside. Things are different this time, but there is little question that the domestic economy's momentum is relatively healthy.
And while I recognize that the situation over there (in Europe) is trumping the situation over here (in the U.S.), we are, to a large degree, ring-fenced from Europe's uncertainty.
With the domestic economy in gear, an $85-a-share 2010 S&P profit in sight and interest rates/inflation quiescent, stocks, in the aggregate, are moving toward levels of value.
A conservatively constructed valuation model produces a S&P objective of about 1,250 to 1,270 (15 times P/E, which is lower than the long-term average but higher than the current 13 times), for about a 15% upside (based on trendline earnings, normalized interest rates, reasonable inflation assumptions and conservative estimates of the equity risk premium).
Buy high, sell low? Not me.
Color me less bearish.