Q&A With Doug Kass

Dan Holland of Real Clear Markets sat down with the always-valuable Doug Kass. Here’s a sample:

RealClearMarkets: You made a huge, once-in-a-lifetime call when you correctly predicted the stock market bottom back in early March-a generational low as you called it. Equities launched an extraordinary rally on cue with your call, and are up over 60 percent as of this interview. Was this good fortune, or was your call borne out of a repeatable investment process?
Kass: Consider the market as a triangle. The bottom left angle is sentiment and the bottom right angle is valuation. On top is the most consequential angle (the one I weigh most heavily) – the fundamentals.
In March, 2009, sentiment and valuation was clearly stretched to a negative extreme. Investors were fearful of “being in” — as a result, retail investors and institutional investors (especially of a hedge fund kind) were at record low net invested positions. At the same time, valuation was pushed down to nearly unprecedented low levels vis a vis “normalized” S&P earnings of about $70/share and were trading at a discount to replacement book value (compared to an historic average of about 140% of replacement book value).
In terms of fundamentals, I had a specific Watch List which helped me gain comfort that stocks were creating a Generation Low. I believe, by following this list, that the process is repeatable.
My Watch List indicators were getting “less worse” six months ago – and that a second derivative recovery was well underway, but, at the time, was being ignored as fear reigned.
Here is a partial check list of (ignored) indicators that I was looking at six months ago which led to my adopting a more favorable stock market outlook:
• Bank balance sheets were being recapitalized.
• Bank lending was slowly being restored as the industry was experiencing record wide net interest spreads and margins.
• Financial stocks’ performance was improving.
• Commodity prices were beginning to rise- a sign that worldwide economic growth was mending.
• Credit spreads and credit availability were slowly improving.
• With affordability at record levels, the cost of home ownership versus renting becoming more favorable and with the Federal Reserve providing a low interest backdrop – a bottom in the housing markets was growing more likely.
• Corporations’ draconian cost cutting was accelerating – sowing the seeds for upside margin and earnings surprise in 2009’s second half.
• Corporations had cut inventories to the bone – a record low level of inventory to sales augured positively for corporate profits.
• There was growing evidence of favorable reactions to disappointing earnings and weak guidance – a sign that the poor operating environment had been discounted.
• Evidence of strength in China’s economy (two consecutive months of a rising PMI) and in its equity market (seen in strong absolute and relative strength in Chinese stock market.
• Market volatility was starting to decline.
• Hedge fund and mutual fund redemptions were easing.
• Pension funds were far too skewed towards fixed income and provided the potential to buoy stocks in a reallocation in the months ahead.

Posted by on September 21st, 2009 at 1:07 pm


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