Is Dow 5,000 Possible?

How low can the stock markets go? Nouriel Roubini, called "Dr. Doom" by many who didn't like his message last year before the markets crashed over 50%, says they can go much lower.

In the best case, Roubini sees the S&P500 (closed yesterday at 676.53 - Charts) at 720, a gain of 6.4%. In the worst case, Roubini thinks there could be another 20% left in the decline with the S&P500 falling as low as 500 to 600 with the DOW down to 5,000 or 6,000.

The good news is he thinks liquidity measures instituted around the world have lessened the chances for a meltdown into a full depression, but there is a rising risk of an L-shaped "near depression" recovery. This means he thinks it will be many years for the economy to recover, not the one year for a recovery as many like Abby Cohen and Bob Brinker believe.

Roubini has argued that, in spite of the sharp fall in US and global equities significant downside risks to stock markets remain. He keeps saying that "repeated bear market rallies would fizzle out under the onslaught of worse than expected macro news, earnings news and financial markets/firms shocks." Yesterday he wrote

If you take a macro approach earnings per share (EPS) of S&P 500 firms will be – quite realistically in 2009 - in the $ 50 to 60 range (I say realistically as some may even argue that in a severe recession they could fall to $40). Then, the question is what the multiple, i.e. the price earnings (P/E) ratio will be on such earnings. It is realistic to expect that the multiple may fall in the 10 to 12 range in a U-shaped recession. Then, even in the best scenario (earnings at 60 and P/E at 12) the S&P index would be at 720. If either earnings are closer to 50 or the P/E ratio is lower at 10 then the S&P could fall to 600 (12 x 50 or 10 x 60) or even to 500 (10 x 50). Equivalently the Dow (DJIA) would be at least as low as 7000 and possibly as low as 6000 or 5000. And using a similar logic we argued that global equities – following the US - had another 20% plus downside risk.

He thinks any rally in 2009 would be a "bear market sucker's rally" driven by temporary improvements in the rate of change (second derivative) in economic growth from stimulus in China and the United States:

Of course you cannot rule out another bear market sucker’s rally in 2009, most likely in Q2 or Q3: the drivers of this rally will be the improvement in second derivatives of economic growth and activity in US and China that the policy stimulus will provide on a temporary basis: but after the effects of tax cut will fizzle out in late summer and after the shovel-ready infrastructure projects are done the policy stimulus will slack by Q4 as most infrastructure projects take year to be started let alone finished; similarly in China the fiscal stimulus will provide a fake boost to non-tradeable productive activities while the traded sector and manufacturing continues to contract. But given the severity of macro, household, financial firms and corporate imbalances in the US and around the world this Q2 or Q3 sucker’s market rally will fizzle out later in the year like the previous 5 ones in the last 12 months.

Roubini thinks US and Global equities could fall another 40 to 50%:

On the downside we have argued here that there is at least a third probability of a L-shaped global near depression rather than the mere current severe U-shaped recession. If a near depression were to take hold globally a 40% to 50% further fall in US and global equities from current levels could not be ruled out. But in this L-shaped near depression the last thing one would have to worry about would be stock markets as more severe issues would have to be addressed (unemployment rates in the mid-double digits – 15% or above - and multi-year stagnation and deflation).

Roubini thinks Abby Joseph Cohen is too bullish in her belief that investors will give the market a PE as high as 17 or more as they discount earnings getting better:

Earlier this year – at the peak of the latest bear market rally - I met Abby Cohen – the ever bullish equity markets expert at Goldman Sachs who predicted a 25% equity rally for 2008 and is making again a similarly bullish call for 2009. I asked her if we disagreed on earnings or on the multiple (P/E). It turns out that our forecast for earning per share for S&P 500 firms are similar: 50-60 range for me, 55-60 range for her. But she argued that a P/E in the 10 (to) 12 range was too low as investors would ignore the bad earnings numbers for 2009: if a rapid recovery of earnings were to occur in 2010 and beyond investors would discount the 2009 bad number and assign to them a much higher multiple of 17 or even more.

Roubini thinks Cohen is wrong. He does not believe we will have a significant economic recovery in 2010.

The trouble with that argument is that, with the US and global economy in a massive slump and with deflationary forces at work it is hard to believe that a massive economic recovery will occur in 2010 thus lifting sharply earnings: even in a U-shaped scenario US growth in 2010 would be 1% or lower and Eurozone and Japanese growth would be close to 0%. Thus, with weak growth deflationary pressure would be still lingering thus putting pressure on profits, pricing power of firms and thus profit margins. Thus, even in a U-shaped scenario a rapid rally of equities is highly unlikely.

Bob Brinker (Brinker Fan Club), like Abby Cohen, has said the same thing about PE ratios and he too was bullish in 2008 for an up year that did not happen. Roubini remains bearish and thinks the markets will bottom in the next 12 to 18 months. He cites how the last recession ended in 2001 and the markets did not bottom until 2002:

Also the “6-9 months ahead forward looking stock market view” is not always borne in the data. During the last recession the economic bottomed out in November 2001 and GDP growth was robust in 2002 but the US stock markets kept on falling all the way through the first quarter of 2003. So not only the stock market were not “forward looking”: they actually lagged the economic recovery by 18 months rather than lead it by 6-9 months. A similar scenario could occur this time around: the real economy sort of exits the recession some time in 2010 but growth is so weak and anemic while deflationary forces keep an additional lid on pricing power of corporations and their profit margins that US equities may – like in 2002 - move sideways for most of 2010 – with a number of false starts of a real bull market – as economic recovery signals remain mixed.

Thus, most likely we can brace ourselves for new lows on US and global equities in the next 12 to 18 months. Eventually a more sustained recovery will occur once we are closer to clear signals that this ugly global U-shaped recession is not turning into a L-shaped near depression and that the global economic recovery is clear and sustained. Until then expect very volatile and choppy US and global equity markets with new lows reached in the next months and the year ahead.

Roubini was correct as the "bear voice" on Larry Kudlow's show during most of 2008 when he argued Larry and the rest of the bulls were too optimistic. I hope he is wrong and the markets recover soon with the Obama and Chinese stimulus efforts. I don't believe anyone can time the markets, but those who are correct in the recent past sure get a lot of press.

Stock position: None.

Comments

[User 371080:]

More like inevitable.

Mar 10 09:46 AM

[investor88:]

We are talking here about Dow 5000 but right now at time of writing Dow is zooming +4%. Maybe another unsustainable rally, only time will tell.

Mar 10 10:38 AM

[Kirk Lindstrom:]

One thing I've learned in 30 years of market observation is "prophets come and go." The longer they are on a hot streak, the more time they get to accumulate money to manage until they have a losing streak at the market timing game.

John Bogle says:

"The idea that a bell rings to signal when investors should get into or out of the stock market is simply not credible. After nearly fifty years in this business, I do not know of anybody who has done it successfully and consistently. I don't even know anybody who knows anybody who has done it successfully and consistently. Yet market timing appears to be increasingly embraced by mutual fund investors and the professional managers of fund portfolios alike. "

"Common Sense on Mutual Funds" pg 20

I joined Roubini's web site but can not find any model portfolios to show what he's advised people to do over the long term with their investments. I'd love to know how long he has been a bear and how well he's done with his money.

Mar 10 10:50 AM

[Mad Hedge F...:]

You are not alone in this view. To say the market has gone mad is an understatement. The Dow has lost 24% since January 1, giving up $2.6 trillion in value. Other than that Mrs. Lincoln, how was the play? Credit default swap risk premiums now tell you that it is much riskier to invest in Warren Buffet’s Berkshire Hathaway (BRK/A) than Vietnam, and that Russia is a safer bet than General Electric (GE). The Dow is headed for the 4,000, according to ultra bear Felix Zulauf of Zulauf Asset Management in Zug, Switzerland. The rock star fund manager believes that we entered a 10-15 year bear market in 2000. He argues that analysts are smoking something with S&P consensus earnings forecasts at $60, down from $100 a year ago, and that the real number will come in at zero to $40. We may see one more bear market rally to 9,000 in the next few months led by financials, mining stocks, and consumer discretionaries. After that the Dow will drop by half. Day traders only need apply.

Mar 10 12:12 PM

[Kirk Lindstrom:]

Remember when the NASDAQ peaked... CNBC loved to have on fund managers like Kevin Landis (I think some of his funds went from $18 to $2...) now they have on perma bears....

I'd love to find out if Roubini was bearish for the past 20 years or was he a bull in the 1990s and turned bear sometime on the way up.

I like to report on what they are saying so I have a record of what they say years from now.

Mar 10 12:36 PM

[Dave Wrixon:]

As it based on Vikram Pandit's view that everyone has a misconception about Citibank, then I would think it is the most unsustainable rally in history. Can this guy even count? And why is he still in charge?


On Mar 10 10:38 AM investor88 wrote:

> We are talking here about Dow 5000 but right now at time of writing
> Dow is zooming +4%. Maybe another unsustainable rally, only time
> will tell.

Mar 10 01:15 PM

[GoMyLittleS...:]

Roubini is fully invested in equities.

Exactly how much do you want to rely on a man who speaks one way and acts a different way?

Mar 10 05:26 PM

[Roger Knights:]

One unexpected shoe that will drop next quarter, as a recent SA article argued, is large earnings-hits from companies being forced to fund their underfunded pension accounts.

Mar 10 07:33 PM

[The AntiCramer:]

I remember Jimmy Cayne telling me Bear was in good shape.


On Mar 10 01:15 PM Dave Wrixon wrote:

> As it based on Vikram Pandit's view that everyone has a misconception
> about Citibank, then I would think it is the most unsustainable rally
> in history. Can this guy even count? And why is he still in charge?
>

Mar 10 09:24 PM

[Fred Voetsch:]

"I hope he is wrong and the markets recover soon with the Obama and Chinese stimulus efforts."

I do not. The leverage needs to be removed and to wish that we avoid pain now means we will deal with it later. The only way to avoid it now is to recreate a credit bubble on top of the existing credit bubble.


"I don't believe anyone can time the markets, but those who are correct in the recent past sure get a lot of press."

I do. I have timed the market all my life just by being objective and only changing my stance from bullish to bearish or bearish to bullish with good reason. I Listen to experts who use hard data and watch for the big trends that everyone else ignores because, "it's different this time."

It is true that those who were right last time are likely to be wrong next time or late to call the next turn. That is why being a bit of a contrarian and always questioning what people are saying is vital to good investing.

Hope is not an investing strategy, it is a sure path to the poor house.

Mar 11 03:18 PM

[Fred Voetsch:]

On Mar 10 05:26 PM GoMyLittleSheep wrote:

> Roubini is fully invested in equities.
>
> Exactly how much do you want to rely on a man who speaks one way
> and acts a different way?

A lot.

He doesn't care about that and tries to remain nuetral. Look at it this way: he has reason to be bullish and to get you and me to be bullish and yet he is bearish.

Read his testimony to congress and you will see how prescient he was. If anything he has been too bullish and optimistic this whole time and is likely still too optimistic.

Mar 11 03:21 PM