IB Net Payout Yields Model

Doug Kass is Net Long?

Oddly one of the most perma-bears known in the financial world has become net long. This is not the first time that he has become bullish as I wrote about on Oct 7th. That turned out to be close to the internal bottom of the market on Oct 10th. Peronally I put more faith in a investor like Kass then an academic like Roubini.

In this long article on theStreet.com, Kass outlines why the negativity in the markets has become so great that he has become bullish. He still expects the recession to last until Feb '09 making it the second longest on record. I'm still optimistic that the LEI (Leading Indicator Index) will lead us out months before that. Its interesting that he mentions a whole list of stuff that he wants to see before becoming overly bullish, yet not one entails this predictor of the future.

The average recession in modern financial history has lasted 10.5 months. The longest recession was between 1929 and 1933 -- real GDP dropped by over 25%! --and lasted 43 months; the shortest (1980) lasted only six months. I expect The Great Decession, which began in November/December 2007, to end in early 2010, or about 12 months from now. If accurate, the current recession will be the second worst on record, having lasted about 27 months.

Despite the fear and loathing on the part of investors, I am beginning to find value and, for the first time in several years, I am in a (slightly) net long position.

Gun to my head, my baseline expectation is that the S&P could end up with a mid- to high-single-digit return for the full year, or about 15% above current levels.

His main reasons for stocks being undervalued. (if the recession lasts until Feb '10 it seems logical to wait several more months to invest).

  1. The risk premium, the market's earnings yield less the risk-free rate of return, is substantially above the long-term average reading.

  2. Using reasonably conservative assumptions (most importantly, a near 50% peak-to-trough earnings decline, which is over 3x the drop in an average recession), the market has discounted 2009 S&P 500 earnings of about $47.

  3. Valuations are low vis-à-vis a decelerating (and near zero) rate of inflation. Indeed, the current market multiple is consistent with a 6% rate of inflation.

  4. Stock prices as a percentage of replacement book value stand at 1x, well below the 1.4x long-term average.

  5. The market capitalization of U.S. stocks vs. stated GDP has dropped dramatically, to about 80%, now at the long-term average. Warren Buffett was recently interviewed in Fortune Magazine and observed that this ratio was evidence that stocks have become attractive.

  6. The 10-year rolling annualized return of the S&P is at its lowest level in nearly 75 years, having recently broken below the levels achieved in the late 1930s and mid 1970s.

  7. A record percentage of companies have dividend yields that are greater than the yield on the 10-year U.S. note. At 46% of the companies, that is over 4x higher than in 2002 and compares against only 5% on average over the last 30 years.


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