Veteran fund manager updates outlook for stocks after correction

Stocks exploded higher in the first quarter, with the S&P 500 gaining 10%.

What's behind that climb? At the beginning of the year, investors were euphoric about the potential for interest-rate cuts from the Federal Reserve. Many expected six such reductions this year.

But sticky inflation (3.5% in March) and strong economic growth (3.4% in the fourth quarter) dashed those hopes. Now many investors expect just two rate cuts this year.

So stock bulls now are pointing to corporate earnings as a booster for stocks, saying net income is headed higher.

As of April 19 a blend of profit numbers for the S&P 500 companies that have reported first-quarter earnings and analyst expectations for those that haven't showed a 0.5% increase in net income for the quarter, according to FactSet.

Investor mania over the growth of artificial intelligence also has boosted stocks this year. That's especially true for the big technology companies, which are heavily involved in AI.

The words of late daredevil Evel Knievel are relevant for stocks, says the hedge funder Doug Kass.Michael Ochs Archives/Getty Images

Strategists boosted stock targets

With stocks rising so much, many strategists raised their market outlooks for this year.

Earlier this month, Christopher Harvey, an equity analyst at Wells Fargo, pushed his year-end target for the S&P 500 to 5,535 from 4,625 previously.

The new number would represent a 9% ascent from Wednesday's reading of 5,060. His S&P 500 prediction is the highest among Wall Street forecasters, he said.

Now, stocks hit a wall at the end of March, and the S&P 500 has slid 3.7% this month. What has caused the decline is unclear, but TheStreet Pro's Doug Kass has a few ideas.

Kass is a hedge-fund manager whose career spans the 1970s and includes a stint as research director at star investor Leon Cooperman's Omega Advisors. He now runs the hedge fund firm Seabreeze Partners.

Kass correctly warned recently of mounting risks that could cause stocks to slide.

Related: Veteran fund manager delivers blunt warning on stocks

Hedge-fund manager Doug Kass's take on stocks

On April 22, Kass reiterated some of the market's problems on TheStreet.com Pro:

Rising geopolitical risks, such as the Mideast conflict and war in Ukraine.Higher interest rates for longer. The Fed predicts that will be its strategy in the months ahead.Prickly inflation and slowing economic growth — "slugflation."Reckless fiscal policy that has led to an ever-larger budget deficit and cumulative U.S. debt load.Heady valuations. The forward price-earnings multiple for the S&P 500 stood at 19.9 on April 19. That's above the five-year average of 19.1 and the 10-year average of 17.8, according to FactSet.

"As demonstrated by the weakening performance of equities during the month of April, risk happens fast," Kass said.

Kass quotes the Evel Knievel philosophy

He quoted the storied daredevil motorcycle jumper Evel Knievel's belief in the two-sided coin of risk. "Risk is good. Not properly managing your risk is a dangerous leap," the deceased Knievel said.

So how do stocks lie now?

Related: Analyst overhauls S&P 500 target ahead of earnings season

"Given the recent fall from grace, stocks have become less overvalued but still remain relatively expensive," Kass said. "That's especially true against interest rates and when compared to the paper-thin equity-risk premium."

The five-year Treasury security yields 4.67%, more than triple the S&P 500's 1.4% dividend yield. The equity risk premium is the estimated return on stocks minus the estimated expected return on Treasury bonds.

Fund manager buys and sells:

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As for Kass's current outlook, it may surprise you, given his comments.

He thinks the pullback has created some opportunities, but you must be selective.

"Although I anticipate a continued market correction, a few individual equities are beginning to become attractive," he said.

"In the market decline over the last few days, I have moved from modestly net short to modestly net long. I anticipate getting longer if more values emerge." (Going short means betting that the stock will drop in price.)

Kass says he plans to buy more "if more values emerge," but don't expect him to buy just anything. "We will be unemotional, disciplined, and analytical in our investment process."

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