The recent weak macro data is pointing towards an economy that is now growing very slowly (if at all), but isn't necessarily retrenching. Over the next twelve or so months, this may amount to limited broad-market equity profits for both the bulls and the bears. (Of course, there are always opportunities to make money-- both long and short-- in individual stocks.)
The "bottom-up" concensus 12-month forward (i.e., Q4 2010 through Q3 2011) operating earnings estimate for the S&P 500 is still approximately $91, but I'm not sure than anyone really believes that figure anymore, as that number was created when growth seemed a lot better than it does now, and hasn't been adjusted since. The "top down" number from S&P's own economists is now around $81, which is approximately in line with the current run-rate level of earnings and makes sense if one thinks the economy is going to stay right about where it is now (but without worsening) next year. (I'm assuming that companies can't cost-cut their way to additional profits, but may be able to maintain current profits until their overly reduced capex spending catches up with them further down the road. And yes, GAAP earnings are far more realistic than "operating" earnings, but if you and I are the only ones who care about that, then what we think doesn't matter.)
If the above assumptions prove to be correct (there are far too many "debt landmines" out there-- both sovereign and household-- to assume anything earnings-wise beyond the next 12 months), then the question becomes: Where should the S&P 500 be priced in a ZIRP environment with earnings flalined at $81, assuming that all the "debt cans" have been kicked down the road into 2012 or beyond?
With a current 12-month forward PE of approximately 14 for the S&P 500 (again, assuming $81 in earnings and the S&P at 1139 at the time I'm writing this), stocks are certainly not cheap because those earnings (under this set of assumptions) aren't growing. And, of course, we all know that traditional bear-market lows occur with PEs down in the single-digits, and we never got there (not yet, at least) in this cycle. But if the "economic landmines" out there manage to stay "unexploded" until at least some time in 2012 (remember, we're in a market that no longer seems to think more than one quarter ahead, much less a full year ahead) and short-term rates stay at zero, it's entirely conceivable that the current level of S&P earnings will support (while also capping) that index in the approximate range it's in now.
Of course, if corporate earnings instead backslide in 2011 to, say, the low $70s because a sliding dollar raises input prices or revenue ticks back down a bit from current levels, the market will undoubtedly see some PE multiple compression to go with such an earnings reduction, and stocks will almost certainly correct 20% or more from where they are now. The question for the bears, though (and I'm one of them) is whether this scenario is still a probability or just a strong possibility. If the answer is "the latter", the odds may favor at least partially covering one's shorts (and I'm currently quite short) at levels commensurate with the end of the market's currently short-term overbought situation and thereby build up one's cash levels, rather than waiting for a major slide that may not occur until a year or more down the road.
Author's Disclosure: Short SPY, Long TZA
