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Updated July 28, 2008 12:01 a.m. ET

LEON COOPERMAN AND STEVEN EINHORN HAVE BEEN WORKING TOGETHER. off and on, since the 1970s, initially at Goldman Sachs. Cooperman, formerly Goldman’s chief investment strategist, started his own firm, Omega Advisors. in 1991. Since its inception, Omega, which uses a long-short strategy and has about $5 billion in assets, has returned 16% annually, net of fees, besting the S&P 500 by 5.50 percentage points. During the first half of the year, it was down 4%, compared with a loss around 13% for the S&P. Cooperman, the firm’s chairman and chief executive, has a reputation as a savvy, rigorous and hard-driving stockpicker. He spends a lot of time trying to make sure we are backing the right horses. Einhorn, the vice chairman, focuses more on the macro picture, the Federal Reserve, market valuation and outlook, and structuring the portfolio.

We are buying plenty of attractively valued securities, but this is not an environment to be complacent, says Cooperman, pointing to high oil prices and the battered housing market. Although he thinks the makings of a market bottom are apparent, Einhorn still sees plenty of head winds, including what he considers to be global money policy that’s out of sync, depleted balance sheets in the financial sector and inflation worries. Other factors to consider, he says, are extreme volatility and a lack of leadership in the U.S. equity market.

Still, Einhorn and Cooperman view plenty of stocks as attractive, as Barron’s learned on a recent visit to their office near Wall Street.

Historically, when S&P drops 20%, when the Fed and Congress are stimulating [the economy], you are in an election year [and] stocks are undervalued versus bondsyou are supposed to buy. — Lee Cooperman, at right in photo Chris Casaburi

Barron’s. Let’s start with the big picture.

Cooperman. We acknowledge that we were somewhat too optimistic about the year. And we basically pressed that optimism in March during the selloff when we largely took off all our hedges. We based that on an old tried-and-true — and tested — approach. We have found historically that when the S&P dropped 20%, which it did from its October peak to its March low, when the Fed and Congress were stimulating [the economy], when you are in an election year, when stocks are undervalued versus bonds and when stocks are somewhat cheaper versus their own history, you are supposed to buy. Basically, every time we went through one of these cycles, there was a vocal minority that said it was different this time. In 1970, for instance, when I was at Goldman, everyone who was negative at the bottom talked about the Penn Central bankruptcy. Thankfully for the system, after each one of those cycles, it wasn’t different. The economy got itself together and we started anew. That was our view in March.

What’s surprised you, subsequent to March?

Cooperman. Oil getting to $140 a barrel and the degree of weakness in housing was much more diverse, widespread and severe than anything we’ve seen. And the credit crunch turned out to be much more of a problem than we could have imagined. More of that problem migrated from Wall Street to Main Street than we allowed for.

Where does the market go from here?

Cooperman. The ingredients for a decent bottom are in place, but any significant upside is going to require help from two areas. No. 1, we have to see a bottoming in home prices. No. 2, we are going to have to see crude-oil prices recede. Frankly, we didn’t forecast crude going to $140 a barrel, so we aren’t confident forecasting that crude is going to $100. In fact, we have two energy experts, and neither believes crude is going much below $120.

Einhorn. The market is protected on the downside by some tail winds that I will elaborate on. But the market is limited on the upside because of housing and crude prices, among other head winds. So it will trade in a range until we can make progress on crude and home prices. As for crude, most of the models indicate that every $10 price increase is worth about two-tenths of a percent of real GDP growth. So if the price goes up $40, it almost costs you a full percentage point of growth in the economy, and it probably costs between $4 and $5 in S&P earnings.

Why do you think that we’re close to a bottom?

Einhorn. Because there are certain tail winds, the first of which is valuation, that protect the market. The market looks attractively priced in an absolute sense and relative to inflation, bond interest rates and to other assets.

What is your price/earnings ratio for the market?

Einhorn. We have a market earnings estimate this year of $90 and next year of anywhere from $92 to $100, and we’ll refine that as the year unfolds. That’s roughly 14 times this year’s earnings, below the long-term average. At the same time, bond interest rates are low, return on equity is well above average and net profit margins are well above average. So the absolute multiple is below average, and corporate profitability, liquidity and balance-sheet strength in the nonfinancial sectors are well above average. Based on virtually any approach, the market is attractively priced. I think it is already discounting a substantial shortfall in consensus earnings estimates.

What other tail winds do you see?

Einhorn. We aren’t expecting the economy to be robust. But at least for now, the economy’s weakness isn’t accelerating, as it typically does in more significant recessions. Another tail wind is that in early 2009, whoever is elected president will introduce a second fiscal stimulus package, most likely larger than the last one, to underpin the economy. Another thing to consider — and it’s been overlooked — is that nonfinancial sector earnings have been above consensus. They may weaken, but so far nonfinancial S&P companies have reported a 10% improvement in earnings, year-over-year. There’s also plenty of investor liquidity. There’s also the Fed. Given the deleveraging going on in the financial sector and that financial stocks are trading close to their cyclical lows, it’s very difficult to imagine the Fed lifting interest rates.

A friendly Fed is an important tail wind that will create excess liquidity in the system, steepen the yield curve and improve bank profitability, which at some point is necessary to begin to rebuild capital. And there is investor sentiment, which is pretty negative. Typically, when sentiment is negative, the market tends to do better.

Are there any particular pockets of the market where you have been finding opportunities?

So these transactions bode well for the market?

Cooperman. Yes, and they are really different than the transactions of five years ago or four years ago or even three years ago, because these recent deals were all strategic in nature. We went through this period of private equity having a very low cost of capital. It was very important that they had a low cost of capital because they were leveraging five to 10 times debt to Ebitda [earnings before interest, taxes, depreciation and amortization].

Einhorn. These recent deals highlight two tail winds. One is the nonfinancial sectors. There are many high-quality companies selling for low absolute multiples and generating significant amounts of free cash flow. That acts as a safety net under the market. Second, even within the financial sector, there will come a time when there will be consolidations that will help start the healing process.

What’s your view of the financials?

Cooperman. The financial economy is in disarray and that is really a result — and you can quote me on this — of imprudent financial activity by the commercial banks and investment banks. They levered themselves up. They did things that were foolish. They should be ashamed of the way they conducted themselves, and now they have to right that, so they are de-leveraging.

Did they get too greedy?

Cooperman. You better believe it. Now, Wall Street is in the penalty box. We are not an investor in that space. I determined many years ago that if you want to make money on Wall Street, you work there; you don’t invest there. They just pay themselves too well. I would rather look elsewhere for investment opportunities.

Let’s talk about specific stocks.

Einhorn. This is a market where you want dominant companies with good balance sheets and that aren’t dependent on financial intermediaries to fund their growth. There are plenty of dominant companies out there that are selling at attractive multiples.

How about another pick?

Other picks?

Cooperman: The HMOs are very cheap, selling at about eight times free cash flow, with decent balance sheets.

Which ones in particular?