Posted by: Ben Steverman on May 12, 2009
Stock investors are sitting on hefty gains from the past two months, when the S&P 500 index has regained 33% of its value.
But there are troubling signs the rally might not be sustainable.
Ed Yardeni of Yardeni Research summarized the problem in a note today:
[…] a bull market needs earnings to keep going. I think they are coming soon, but they aren’t here just yet. The bad news is that despite Q1’s positive earnings surprise, industry analysts continued to cut their estimates for the remaining three quarters of 2009. Their 2010 estimate is also still falling.
Last week, analysts’ estimates for S&P 500 earnings in 2009 and 2010 fell to new lows for this recession. Yardeni added:
I am especially concerned about the ongoing weakness in forward earnings because these data tend to be excellent leading economic indicators and predictors of the earnings outlook over the next 12 months. To keep the stock market rally, these need to start confirming the other data showing that an economic recovery is coming soon.
I think there are essentially three different ways to interpret the current stock market rally:
1. This is a false dawn. Investors are expecting a recovery in the second half of 2009, and they’ll be very disappointed when it doesn’t arrive. Unemployment is heading higher and could send the economy into another tailspin. So might financial shocks from the rest of the world. Stocks could easily return to their March lows, or fall below them.
2. This was a relief rally. Investors have decided the world isn’t headed for a second Great Depression after all. To maintain these gains, the economy and earnings don’t need to rebound strongly. They must merely tread water for a while. By stabilizing, they prevent a re-testing of the March lows but don’t necessarily guarantee future gains.
3. The economy has already begun to stabilize and a recovery for the economy and earnings are inevitable. This rally has just begun.
I don’t claim to know which scenario is correct, and, in these crazy times, I’d be suspicious of anyone who does.