This commentary originally appeared on Real Money Pro on Nov. 11 at 8:20 a.m. EST.
Two roads diverged in a yellow wood,
And sorry I could not travel both
And be one traveler, long I stood
And looked down one as far as I could
To where it bent in the undergrowth...
I shall be telling this with a sigh
Somewhere ages and ages hence:
Two roads diverged in a wood, and I
I took the one less traveled by,
And that has made all the difference.
-- Robert Frost, "The Road Not Taken"
The world, it seems, is almost universally bearish these days -- and is generally aligned with Bobby's views.
We seem to be approaching the polar opposite in sentiment that was in place in the summer of 2007, when I was in a small minority -- that is, unequivocally bearish and all-in short based on concerns regarding the proliferation in derivatives, the speculation in the housing markets and the world's economy and stock markets. I was also in a small minority in March 2009, when the world as we know it seemed to be falling apart. The pendulum of the bullishness of 2007 had, at that time, morphed into fear that has rarely been seen in the past century. And that fear, paved the way for a generational low for the U.S. stock market, which I predicted on these pages and front and center on CNBC's "The Kudlow Report" and "Fast Money" in March 2009.
Today the bearish cabal is increasingly ardent and confident. And why shouldn't they be, given the challenges that face our domestic and the world's economies? After all, the residue of the past cycle has now been manifested in the structural disequilibrium in the labor markets; the headwind of a massive unsold shadow inventory of homes for sale; the screwflation of the middle class; and, most importantly, the large fiscal imbalances at the local, state and federal level in the U.S. as well as the similar problems facing the eurozone.
We have been in a post-Lehman-bankruptcy holding pattern for three years. The recent market volatility is embodied in the history of market and economic transformations, as we are in a highly interconnected, non-linear, dynamical system that typically oscillates wildly before changing state. Ultimately, we will settle into a new pattern -- hopefully it's a bullish one! -- but we will likely never return to the identical environment previously in place.
We can't say for sure what the current volatility means. As an acquaintance wrote to me last night, we can't say for sure whether it "signifies a coming collapse of the banking system. We can't say for sure that this signifies a historic rally in which the market will be up 20 straight years. We can't say for certain that Karl Marx was right and this is the beginning of the transition to worldwide communism and bliss." What we can say with confidence is that we will ultimately exit the post- Lehman holding pattern and that we are headed toward an unknown destination. So, I am confident in my lack of confidence, recognizing that it might take a while to find a new stability in the economic and stock market order.
For all I know, the bears will be right -- and I recognize that the crowd usually outsmarts the remnants -- but what I am certain about is that the above negatives are well-known and, importantly, there is recognition that change (austerity and fiscal discipline) is what we need around the world. I also know that the unimaginable rarely happens (though it did occur in 2008-2009) and that, as unlikely as it appears today, history demonstrates that our world's leaders ultimately rise to the occasion during crisis.
And, increasingly, those headwinds appear (as I have documented lately) to be in the process or have been completely discounted in today's below-average valuations.
Below is an anecdote that highlights the unanimity of opinion (of a bearish kind) and the fact that individual and institutional (especially of a hedge-hogger kind) investors have derisked.
I am a member of the board of trustees of a university and vice chairman of its investment committee, which supervises a $100 million endowment. Yesterday, I attended a two-hour investment committee with the asset management company to which we outsourced the manager search and management supervision.
What was abundantly clear is that the selected managers are at record levels of defensiveness and their quarterly letters underscore their negativity. Not one of the 20 or so managers expressed optimism, and those that were net long almost seemed apologetic.
In support of an overriding pessimistic outlook by most investors, my well-to-do friends who have money with hedge funds often send me the managers' quarterly letters, which today ring out with historically large cash or short positions. Not just a few of the managers have implemented tail-risk strategies (e.g., huge out-of-the-money puts, etc.) that position them for the next black swan event.
I always try to test my views through thoughtful analysis, adopt scenario probabilities and valuation methodology, but there is a well-documented psychological tendency in investors to be overconfident in the correctness of their opinions. Too often, when we look at the investment world we see our own opinions. Whether bullish or bearish, a myopic and fixed view can be harmful to your financial health. The basic truth is that an investment view must be flexible and objective, as the investment mosaic and stock market outlook is complicated and always in motion.
Perma-bulls are evolutionarily adapted to picking berries in an often lion-infested African savannah; the perma-bears are plagued by the opposite condition.
History shows that (in investing and in life) pride always comes before the fall. Beware of both species as they are attention-getters, not money-makers, and it usually pays to graze somewhere in between the bulls and the bears.
My investment methodology applies a probability of confidence multiplier to four economic and stock market scenarios, and that approach yields to my (always qualified!) conclusion that an attractive risk/reward ratio exists today for investors in the U.S. stock market.
Color me more bullish (part deux!).
Doug Kass writes daily for Real Money Pro, a premium service from TheStreet. For a free trial to Real Money Pro and exclusive access to Mr. Kass's daily trades and market commentary, please click here.