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The Real Reason Stocks Are Falling


Monday was another down day for the market, with the S&P 500 index falling 1% to another 12-and-a-half-year low of 676.53.

There’s been a lot of talk lately about the Obama administration and the stock market, some of which I’ve contributed to. But let’s not forget there are strong explanations for the stock market slide beyond politics.

The stock market took Friday’s dismal jobs report in stride, probably because investors were already expecting nasty data. But it was a terrible report nonetheless. Warren Buffett said Monday that the economy has “fallen off a cliff.” Economists who studied the report are now lowering estimates for the rest of the year.

Like Deutsche Bank’s (DB) Joseph LaVorgna. He lowered his estimate for third quarter GDP from zero growth to a 1.5% decline, and fourth quarter from positive 1% to negative 0.5%:

The unemployment rate, which we previously expected to rise to 8.7% by year end and peak at 9.2% in Q1 2009, we now see rising to 10% by year end with a peak of 10.5% by the middle of next year. Although, given the fragile state of the economy, particularly the Big 3 automakers, we worry that the unemployment rate could top 11%.

So much for the economists. What about the other side of the trading floor, where the technicians are huddled over their charts?

You can read for yourself today’s take by Schaeffer Investment Research’s Todd Salomone. It won’t cheer you up. He writes:

A bottom will occur when there is a lack of interest in attempting to call a bottom, or there is a belief that a bottom is nowhere on the horizon. Unfortunately, we are still not seeing the despair that is usually found at major market bottoms.

Some analysts believe the S&P 500 could stop falling at the 600 level, which Salomone writes:

…would represent a multiple of 12 times earnings, based on estimated earnings for the SPX of $50. One has to wonder if anyone can call the bottom based on valuations, as future earnings estimates are questionable at best. Moreover, why a multiple of 12?

An article in Monday’s Wall Street Journal, “Dow 5,000? There’s a Case for It,” looks at the various scenarios for earnings and what they mean for stocks:

Looking solely at valuations, namely price relative to earnings estimates, the S&P at 500 isn’t necessarily a wild stretch. The current 2009 earnings estimate for S&P companies is about $64 a share, down from about $113 last April, according to S&P. Goldman is now predicting $40, having cut its forecast from $53 in late February. Bank of America Merrill Lynch estimates $46 a share, and Citigroup is predicting $51.

The S&P 500 had a forward price-to-earnings ratio of 11.3 in the bear market of 1974 and 8.5 in 1982. “Put a multiple of 10 with estimates of $40 to $50 a share and the S&P comes out at 400 and 500,” the WSJ writes.

For the record, stocks are now trading at September 1996 levels, and in the 12 months before September 1996 the S&P 500 earned $39.40 per share. That was a trailing P/E of 17.

In my opinion, investors won’t get much from wading into all this discussion about valuations, technical indicators and market sentiment. Except perhaps a headache. All the numbers and historical comparisons just add to the confusion, especially when this year’s earnings are mysterious at best, as are future growth prospects which help determine P/E.

Market chatter about politics in Washington is interesting because policy choices may affect earnings or the economy. However, exactly how that will happen is hardly clear, and partisanship and ideological prejudices make reliable predictions hard to find.

So, at the risk of stating the obvious, I’ll try to boil down my take on the market:

Compared to expectations, the economy is getting worse, hand in hand with the outlook for corporate earnings. So, the stock market is moving lower.

The stock market could rally temporarily for any number of reasons (i.e., technical factors, valuation arguments, policy changes). But no rally will be sustainable until the economy and earnings prospects stabilize.


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