4 Steps to 1050 for the S&P 500

The Fourth of July is just four days away. So, how about a four step process to investment fireworks for this summer?

The media is attributing Tuesday's stock market swoon as being driven by the disappointing report on US consumer sentiment. No doubt it is a contributing factor, however, a single data point does make a trend, for when one expands the time horizon beyond the day, a decidedly bullish trend has emerged over the past 8 weeks as the above table clearly shows.

Investment Strategy Implications

The investment implications for the above consensus results rests in the likely upward adjustments economists will make to their forecasts, which will in turn produce increased earnings expectations from bottom up analysts. As noted previously, this would occur for the following reason:

Earnings (cash flows) are one of the key fundamental-analysis inputs upon which valuation (and therefore investment) decisions are made. The fundamental premise is that, in the aggregate, current earnings expectations incorporate the consensus view. Therefore, whenever macro economic reports come in above or below consensus expectations, economists change their outlook, which in turn cause individual company analysts to adjust that macro economic component of their industry and company forecasts. However, since this process occurs with a meaningful lag, investors can gain a competitive advantage by anticipating changes to earnings forecasts as the above or below consensus reports are filtered into the forecasts.

In regards to current earnings expectations, consider the following statistic from contrarian value investor and behavioral finance expert, David Dreman (from last week’s NYSSA conference): from 1973 through 2008, the average analyst forecast error is 39%. That means that 2Q09 operating earnings for the S&P 500, currently estimated by bottom up analysts at approximately $14, may actually come in as high as $19.50 or as low as $8.50.

In light of the consensus data noted above, the lag component of the forecasting process, along with an increasing number of economists estimating that the trough of the recession was reached this quarter, it would not surprise me if the 2Q09 earnings reports tilt more toward the higher number. Should that occur, then all the angst heard over the past few weeks regarding low volume would dissipate rather quickly as some of the $3.5 trillion still sitting in money market funds moves off the near zero percent interest rate sidelines.

And if that were to occur and stocks made a strong move to the upside, then old school market technicians will ring the bullish bell as completed bottoms and moving average signals will abound.

So, here is how a major bull market begins in earnest:

1 - Above consensus macro economic readings produce
2 - Above consensus earnings reports which
3 - Moves funds moving out of money market funds which produce
4 - Bullish readings by old school market technicians which results in

1050 or higher in the S&P 500.

Let the fireworks begin!

Comments

[Maxe Paul:]

Be careful as people who play with fire(works) often get their fingers burnt! Good luck though.

Jul 01 08:58 AM

[CBTeas:]

Vinny: I respect your work, but like many intelligent analysts, you do not respect the ever rising savings rate in this country. This is not a normal recession or recovery. Don't confuse a slowing economic rate of decline with a soon to be expected rapid rise in earnings.

THIS TIME, things will lag badly as consumers have to repair via years of increased savings. There is a better chance of missed earnings...not excessive earnings or rising expectations. Don't compare this recession to anything you have lived through. This is a recession none of us have ever seen. Corporate earnings are just part of a huge economic zero sum game and something has to give...

Jul 01 09:08 AM

[tradeking13:]

"...the $3.5 trillion still sitting in money market funds moves off the near zero percent interest rate sidelines."

Obviously you are not familiar with the concept of a secondary market. When I take my "sideline cash" and buy stock, the seller now has that cash, so the net effect is zero. That is, the seller who formerly held the stock is now on "the sidelines".

Jul 01 11:15 AM

[Fitz919:]

I'm not impressed with your data points or your conclusions.

Jul 01 07:58 PM

[jeandit75:]

Vinny, you are nuts

Jul 02 02:40 AM

[AndrewBaker:]

On Jul 02 02:40 AM jeandit75 wrote:

> Vinny, you are nuts

I agree! What's he on or who's paying him? It's either very strong medicine or lots of money, and I hope he doesn't waste it going long the market right now.

Jul 02 09:59 AM

[Igor Shumovich:]

Well, a month later, with SPX above 1000 - Vinny was right and the rest of the herd commenting on his article were, well just a bit ignorant...

Aug 05 10:34 PM