Impossible, Improbable, or Impending?
Created 3/09/09
For stock market investors, two major questions should loom large. Both are presently very difficult to confidently answer. The first is when and where a final “bottom” might occur in the stock market? The second is how might the stock market “price” negative full-year earnings for the S&P500, should a year of negative earnings actually occur?
Any number of methods to determine a stock market “bottom” can be deployed. Perhaps it is easiest to classify the two distinct primary methods as Qualitative (Fundamental) and Quantitative (Technical) Analysis.
Qualitative analysis of a potential stock market “bottom” is particularly difficult to perform, given the uncertainty over the economy and its impact on businesses. Forward earnings visibility seems hazy, at best. Therefore, given this uncertainty, it is difficult to envision an earnings figure for the S&P500, as well as what type of earnings multiple the market might assign to such a number. There is certainly a possibility of having a full year of negative S&P500 earnings (i.e. a loss), which would be a first occurrence. If this were to happen, how might the stock market price such a condition? It is difficult to say; however, it would most likely depend upon the forward outlook at the time. A brief dip into negative earnings, followed by a quick, sustainable economic rebound could serve to “buoy” the S&P500. In this scenario, the market would presumably believe the dip into negative earnings to be transitory. However, if the market believes such a fall into negative earnings territory to be (more) lasting and undefinable in duration, it would most likely price the S&P500 to discount such a scenario. To the extent that forward revenue and earnings prospects were viewed as weak, the market would likely suffer accordingly. In this latter scenario, overall fear, uncertainty, and an implicit acknowledgement of various facets of systemic risks and hardships would present themselves.
Quantitative, or Technical Analysis, might offer guidance, but as those familiar with it know, any situation can be interpreted in a number of ways. Notwithstanding this “flexibility,” one area on the long-term chart of the S&P500 seems especially prominent from a technical perspective. This area is what many consider the start of the current long-term bull market, the price level of approximately 100 seen in August 1982. One way, seemingly drastic, to interpret this level is to think of it as potential support at the 100% retracement. A 100% retracement of a multi-decades old bull market in a broad index would seem extreme. However, there are at least three factors that might support the idea of at least considering such a 100% retracement scenario. First, since the financial crisis began, outliers and other “odd occurrences” have propagated on a vast scale. The mere existence of such an array of outliers would seem to argue that one should be open to possibilities that normally one wouldn’t, or shouldn’t seriously consider possible. Second, S&P500 price action is not only poor – it is disconcerting on an “all things considered” basis. Third, a quick visible scan of the long-term charts raises a troubling specter – a lack of clear, potentially strong technical support – until one sees a S&P500 price of 100. Of course, as aforementioned, this technical observation is open to interpretation.
Another important question arises from a technical perspective. If the S&P500 were to reach the 100 level, would such a level represent a “true bottom” from which a lasting new bull market might arise, or would it represent a temporary bottom from which a “strong bounce” might occur? If it were the latter, the stock market at some point would revisit the 100 area and then fall through it.
Should the stock market fall to the 100 area, what might be the timing? Again, this is a difficult question. If one were to casually answer, one might think such a decline from the October 2007 highs might occur in a 3-5 year timeframe, perhaps longer. However, there obviously isn’t much precedent in the stock market for this type of scenario. Some might reference the price history of the Dow Jones Industrial Average during the Great Depression as an analog, given the drop from the highs during that period would rival the drop from the October 2007 highs to a S&P500 target of 100. However, having one incident of historical precedent, and one that happened during a different set of fundamental (and technical) circumstances hardly would seem like a precedent one would prudently rely upon as a single-point benchmark. Might such a drop to the 100 area happen in a more compressed time period? Could it happen in 2009?
If one were to assume a S&P500 level of 100, one might wonder about the concomitant economic conditions. Such pondering is difficult, due to an array of factors. One factor that might accompany, if not be a significant cause of, a drop to the 100 area is a rise in company (and individual) insolvencies. Otherwise, back-of-the-envelope calculations indicate an economic environment at a S&P500 level of 100 likely to be ghastly, probably matching or surpassing the headline economic statistics of the Great Depression – and having embedded problems of a more complex nature.
It should be noted that presently, a S&P500 target of 100 is not even being mentioned as a possibility by any mainstream brokerage, financial publication, or any other type of advisory/research service. Furthermore, the type of draconian economic environment that would likely accompany such a target is wildly disparate to that being mentioned by economists and prominent financial professionals, who, on average, are forecasting an economic trough that seems well within the bounds of seeming rationality.
Hopefully a S&P500 price significantly less than current levels of 670, as well as the accompanying economic weakness, will fail to materialize and any thoughts of such an occurrence can remain in the realm of implausibility.
The S&P500 at 100? Impossible? Improbable? Impending?
Imponderable?
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