The Stock Market's Problem is No Longer Housing and it is No Longer Financials

The problem is now that the entire economy dried up in January. Everything stopped.

You speak to anyone in any industry these days, and the remark is the same - "I just cannot believe how bad the January numbers were."  Then, you may hear some sort of explanation of how they were then down 40% or something like that month over month.

The routes of this problem are many and they are easily traceable.  It is overleveraged banks that could not / cannot be saved.  It is an overleveraged consumer who is unwater in their house.   It is a global system that drank from the punch bowl for over a decade. 

Unfortunately, when push comes to shove, finding the routes don't do anything for the future of the stock market.  I've seen a lot of discussion on this website and others suggesting that the stock market is cheap and now is the time to buy.  If you believed all of that hype on the eve of Obama's election, you would have ridden the market down from 9500 on the Dow to 7100 yesterday.  Unfortunately, the hype today is just like the hype of November, except the economy has deteriorated so fast and so far in the meantime that the prognosis is now weak.

There is only one proven way to value a stock or a portfolio of stocks, and that is a multiple of earnings (the P/E ratio).  In college or business school, they'll teach all sorts of other valuation metrics to account for dividends, growth, etc., but it ultimately comes down to the P/E ratio.  The S&P 500 is now trading at 740.  Economists are now predicting that the S&P 500 will earn $50 this year.  Financial analysts had predicted $60 a few weeks ago, but are now gradually moving their estimates to $50.  A 12x P/E multiple is appropriate for most stable markets and a 14x P/E multiple is aggressive for a very fast growing quick recovering multiple.  As the market starts to accept that the $50 figure, we are likely to fall towards 600 on the S&P.  Unless expectations for 2010 start to fall dramatically, that will be a good entry point.  The unfortunate thing is that it is a lot lower than where we are now. 

Herman Kline
Herman Kline: Herman is a recent graduate of Wesleyan College with a strong interest in finance and firm belief that General Electric is a scam on the public perpetuated by Jack Welch and Jeff Immelt that will ultimately fail to do hidden off-balance sheet liabilities. Herman's favorite place is on the side of a mountain or rock climbing wall.

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