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.

The market’s P/E multiple is up by 5.5 points, or more than 40%, since equities bottomed in early March. So, even for the bullish strategists, the phase in which expanding price-to-earnings multiples contribute to the market’s advance is largely over and future stock market gains will be dependent upon the achievability of a healthy growth in S&P operating earnings toward the consensus.

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.