Will SPY Reach 2002 Levels?

Question:

Why wouldn’t it be prudent to assume that SPY will decline to AT LEAST $70 (the 2002 level) before rallying above the recent 80 to 95 trading range?

Compare Today To 2002:

• We are in the worst national economic crisis in more than 75 years, 2002 was no match.
• We are in the worst global economic crisis in over 100 years, 2002 was no match.
• 2008 saw the largest percentage decline in quarterly and annual profits in many years, larger than the decline in 2002.
• Absent the corporate leverage available in 2002, future earnings growth will probably be lower than subsequent to 2002.
• Uncertainty and lack of earnings visibility prevails, much more so than 2002.
• Markets are massively government policy dependent, and major governments are all operating in uncharted economic and policy territory, no comparable situation in 2002.
• Current low interest rates (2.5% 10-yr Treasuries versus 4% to 5% in 2002) are not likely sustainable long-term, as Treasury buyers demand higher rates to compensate for higher Treasury default risk and future inflation.
• 2008 “as reported” S&P 500 EPS is approximately equal to 2002 “as reported” EPS, and are not expected to grow as fast in the future as they did after 2002.

S&P 500 “as reported” earnings history and forecasts:

• 2010: $39.59
• 2009: $32.41
• 2008: $27.69 <<
• 2007: $66.18
• 2006: $81.51
• 2005: $69.93
• 2004: $58.65
• 2003: $48.74
• 2002: $27.59 <<
• 2001: $24.69 <<
• 2000: $50.00
• 1999: $48.17

Long-Term Monthly Chart of SPY:

Observation:

If the 2002 lows are touched, we would have an approximate 22% SPY price decline ahead of us. Even at $70, SPY would be trading at an above average multiple of forward earnings. Much more severe SPY price declines are possible.

In the absence of a major change in economic prospects, we think prudence requires keeping the US stocks allocation in cash until the price rises above the current trading range.

We would rather be late to the next bull than early to a possible extension of this bear.

Comments

[Moon Kil Woong:]

Yes, thanks for reminding us of the potential downside and why we are all conservative right now. Such a fall is plausible and real even though we prefer not to think we are looking for such a big drop.

My friend pointed out to me today that if 2009 doesn't markedly improve it is likely we will see a lot of new lows in 2010. Maybe more like another 50% drop. Not a cheery thought.

Feb 17 04:33 AM

[scimitar:]

A very well-written, sobering article. Based on the fundamentals, one would think that we will see a return to 2002 valuations on the S&P 500. The last decade of so-called "returns" was a complete fraud, based on greed, arrogance, and widespread stupidity on the part of corporations, citizens, and regulators alike.

If anything, the massive credit losses predicted by Roubini are just getting started, and despite the feeble attempts from the powers that be to prop up the market, we will ultimately have to go lower before we can recover. It's a difficult environment, but prudent and cautious investors can still make money. However, there are millions of people who will now suffer due to the failure of a few. I'm surprised they aren't demanding public executions of those responsible yet. The anger and fear are palpable.

Feb 17 06:11 AM

[Jim Hawthorne:]

Thanks for another 'down-to-earth' submission! We are indeed in the weakest position we have been in for over 30 years. Lest anyone doubt the severity of our position, your bullet points would even look more gloomy had you stressed that consumerism (and production) fell off a cliff last fall, sentiment has taken a swan-dive, employment is sinking (and the life-boats are already full), and a rising number of our States and cities are in danger of falling into bancruptcy.

At least some of the warnings of Roubini and others, contemptuously ridiculed a year ago, now appear quaintly understated, and some of the more dire predictions have already been exceeded.

Most troubling to me is this: back in 2002 (and also back in the early 1990's) at least there were clearly visible drivers available that could be fired up to winch us up out of recession. Today, there certainly is no 'quick fix' available and it has become most difficult to envision a road map out of this for the longer term.

I agree with the other commenters that prudent conservatism should mark our investment decisions at this time!

Feb 17 07:30 AM

[investor88:]

I could be wrong but looking at the spy chart and the dire state of affairs, the trend is down and spy could be 40 [some 50% drop] before the market bottoms out.

Between spy 40 and 1000 there will be good trading trading opportunities [long and short] for those with skill in trading and controlling risks.

Feb 17 07:45 AM

[investor88:]

Correction to the note above, I mean "between spy 40 and 100".

Feb 17 07:46 AM

[morph366:]

An increasing number of instituitional fund managers are beginning to question the validity of a "V" shape to the recovery - never mind when it might start - and this suggests that the outlook for future P/E's should not be comparable to the 2003-5 period.
Once that more sombre view becomes more widely held - perhaps after all of the hoopla regarding Mr. Geithner's plans are known - that could remove the recent support for the S&P 500 in the 800 region.

Feb 17 08:38 AM

[mariocavolo:]

your comments are greatly appreciated and easy to agree with. It seems there is a "mysterious" force of buying holding up the markets....some say it's the gov'ts PPT Plunge Projection Team, sending zillions of gov't dollars through select investment banks into the market to prop it up. I dont know, but I do know that there is no way the market should be as high as it is and is due downward as you and many of us know it "should" do....Cheers

Feb 17 08:44 AM

[prudentinve...:]

Sobering article. Numbers don't lie, and the reality certainly allows for another significant leg down.

Eventually, things revert to their mean trendline. SPY tried valiantly to unwind the dot-com bubble and get back to its long-term historic trendline in 2002-2003, but the fed thwarted this needed and natural correction with 1% interest rates and the credit bubble. Now the market is again trying to revert to trendline, but again the fed may succeed in thwarting it, temporarily, with ZIRP/QE. If they succeed, the pain may be lessened in the short term, but extended as the market will again try to revert to its mean, long-term trendline.

Feb 17 08:56 AM

[Jim Hawthorne:]

morph366, what you say is quite right, and has a couple of nasty consequences;
1. as the markets froth and bounce around sideways, they burn off their 'oversold' energy as a function of time, and therefore become vulnerable to even greater and more violent declines.
2. the drops from 'limbo level' to 'limbo level' reflect a gathering social mood of despair and gloom that it itself self-defeating.
3. we move into 'Missouri market' where investment demands a 'show me' or wait and see attitude before committing rather than assuming and anticipating inevitable positive returns.

On Feb 17 08:38 AM morph366 wrote:

> An increasing number of instituitional fund managers are beginning
> to question the validity of a "V" shape to the recovery - never mind
> when it might start - and this suggests that the outlook for future
> P/E's should not be comparable to the 2003-5 period.
> Once that more sombre view becomes more widely held - perhaps after
> all of the hoopla regarding Mr. Geithner's plans are known - that
> could remove the recent support for the S&amp;P 500 in the 800 region.
>
>

Feb 17 09:02 AM

[y3115y:]

I agree with you 100%. Every economist should read this article.

Feb 17 09:03 AM

[Mad Hedge F...:]

In three short weeks we have gone from an administration that had a political interest in portraying the economy as not as bad as it really was, to one that paints the economy as worse than it really is. The markets don’t like it. It says a lot that the Dow is taking a run at a new six year low, and is perilously close to a 12 year low, the day Obama signs his stimulus package.

Feb 17 01:07 PM

[the ilster:]

Nice Job! I think its a no brainer.... thank god I am currently short

Feb 17 11:32 PM

[Brian Dightman:]

Thanks Richard, I enjoy your work. I have found using P/E’s to establish entry points in broad market positions difficult. For example, if investors wait for PE multiples to arrive at or near 15 (your approximate as reported P/E average), they may find the market has left them behind. In the last bear market the as reported P/E did not hit a low until the end of 2006 at 17.4, well after markets advanced from lows hit in late 2002.

I realize it was the day you wrote the post but we are essentially now at 2002 levels and I find the current environment tempting. I raised cash throughout the first part of 2008 and experienced only small declines in strategies for the year. I do expect more downward pressure on U.S. stocks base on the contraction in consumer spending that is likely to stay with us until the employment and housing situations improve. I’m not sure we will get to a level where the P/E on as reported earnings hit 15. My concern is that with huge amounts of cash sitting on sidelines when the market does start to move it is going to do so swiftly and may consolidate at a higher level. In summary, I would argue the risk level for starting to re-enter the market at this level is fairly low. We have had a healthy 50% delince from market highs. Can it go lower, sure? If it does it is not likely to stay there for long...unless we are a repeat of Japan in the 90's. Proceeding with caution.

Feb 18 06:37 PM

[Bartlesby:]

Brian - while your point on market timing using PEs is certainly valid, consider that 424/500 companies in the index have now reported an aggregate net LOSS of $11.97 for Q4 2008. This puts the SP500's ttm EPS at $26.16, which gives us a current multiple of nearly 30. While the quarterly loss may be exaggerated by one-time writedowns, we are still significantly overvalued at these levels.

Even an overly optimistic PE at 20 would give us an index level at roughly 523. We should be careful to assume that the downside is limited when the index history tells us otherwise.

On Feb 18 06:37 PM Brian Dightman wrote:

> Thanks Richard, I enjoy your work. I have found using P/E’s to establish
> entry points in broad market positions difficult. For example, if
> investors wait for PE multiples to arrive at or near 15 (your approximate
> as reported P/E average), they may find the market has left them
> behind. In the last bear market the as reported P/E did not hit a
> low until the end of 2006 at 17.4, well after markets advanced from
> lows hit in late 2002.
>
> I realize it was the day you wrote the post but we are essentially
> now at 2002 levels and I find the current environment tempting. I
> raised cash throughout the first part of 2008 and experienced only
> small declines in strategies for the year. I do expect more downward
> pressure on U.S. stocks base on the contraction in consumer spending
> that is likely to stay with us until the employment and housing situations
> improve. I’m not sure we will get to a level where the P/E on as
> reported earnings hit 15. My concern is that with huge amounts of
> cash sitting on sidelines when the market does start to move it is
> going to do so swiftly and may consolidate at a higher level. In
> summary, I would argue the risk level for starting to re-enter the
> market at this level is fairly low. We have had a healthy 50% delince
> from market highs. Can it go lower, sure? If it does it is not likely
> to stay there for long...unless we are a repeat of Japan in the 90's.
> Proceeding with caution.

Feb 20 12:18 PM