A Nervous Day

My operating model has been that we are in a prolonged sideways market.  We will be bound in a trading range with the Nov. 20, 2008 close (about 750 on the S&P) as the low and a top end as high as 950.

These are rough ranges, and we could set a new low, but my assumption is that it will not be too much below 750.  My model is that we will trade within this range for some time – perhaps for the rest of this year.  Any breakout will be temporary until some significant new economic news occurs.

Yesterday we had yet another plunge in the markets and we came close to the low end of the range, so market action today was important to watch.  Would we have a collapse?  Bounce off the bottom?

Compounding my concern was the drumbeat of terrible economic news, including reports on the Fed’s warning that 2009 will be much worse than previously thought.  So much for a second half 2009 recovery.

But most troubling to me has been the lowering of forecasts for 2009 S&P 500 earnings.  If we assume the S&P is 750 and use an “average” P/E of 15, this implies earnings of $50.  Up until recently, this was a reasonable lower-range estimate and provided my hope for a floor of approximately 750.

Recent earnings reports and forecasts have caused many economists and strategists to lower their 2009 forecasts.  The latest number I’ve seen is $46, from an economist who is labeled a “perma bear” but who has been right lately.  Using a P/E of 15, that places a floor at 690, 8% below my floor.  But, using a P/E of 10 – a P/E that historically marks the end of a secular bear market and beginning of a secular bull – we get a valuation of 460.  A drop to 460 would be catastrophic.  It would represent a drop of 71% from the market high in October 2007.

This is certainly in the realm of possibility.  The NASDAQ dropped more than this following the burst of the Tech Bubble.  The Nikkei dropped more than this in the early 1990s.  The Dow dropped more than this in the Great Depression.

I’m not predicting a drop in the S&P to 460.  But now that earnings are being revised downward even further, I am nervous when we approach the 750 level.

Perhaps part of the resiliency in the market today came from President Obama revealing the “3rd leg of the stool” in his economic recovery plan – help for homeowners – along with previously announced help for banks and job creation via economic stimulus.  As I have said before, none of these plans are perfect, but I am definitely of the opinion that Obama is doing the right things.


One response to “A Nervous Day

  1. I’ve been hearing the 500 number thrown around by some of my associates who seem to have their stuff together. The latest blow – inflation numbers – seems to indicate an even greater pending drop in spending. I am by no means a Gold Bug. But, I can see why folks are looking that-a-way. I can sit at home, whiling away my days, eating freeze-dried food, counting my gold coins while I clean my guns. ACK!

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