Longer-Term Price Targets for SPY

We believe SPY will test $105 for support (down about 9% from about $116 today).  We believe that if support is not found there, it may test $80 for support (down about 31% from about $116 today).

We calculate that if SPY reaches the 80-year average P/E based on trailing 12-month “as reported” earnings, it will be priced at roughly $96 (down about 17% from about $116 today).

Overall then, in light of the clear down trend forces in the market, we see a near-term decline of 10% to 30% ahead of us for SPY (and the S&P 500 which it represents) as being possible to probable.

Of course, if and when the “E” is expected to grow more rapidly or is reported at higher levels, the price points would be higher — but there isn’t much to support that optimistic view that we can see.

Counterpoint:

An article in Barron’s this week had an interview with Merrill’s Richard Bernstein who predicted a rising S&P 500 over the next 12-months.

After the Bubble, How Capitalism Will Survive
Richard Bernstein, Chief Investment Strategist, Merrill Lynch

Barron’s: The S&P 500 was trading at around 1200 late last week. Where do you see it going over the next year?

Bernstein: Surprisingly, our models still show a return of about 6% for the S&P over the next 12 months. We have about seven different models that we use to come up with that 6%. What is very interesting is that in the last two or three months, the dispersion of forecasts for these models has gotten incredibly dramatic and has been skewed downward.

So the 6% forecast is the median, not the average, which is about minus-18. We have always used the median to try to remove some of the volatility. But we’ve never seen that gap before between the mean and the median.

Charts Supporting Our Near-Term View:

These two charts illustrate the technical and fundamental basis of our price point estimates.

click images to enlarge

The chart above postulates support at $105 at the extension of the line from 1992 through the post-Dot.com lows to Tuesday (blue line); and potential support at $80 at the post-Dot-Com bottom (red line).

The chart above includes Standard & Poor’s historical P/E ratios from 1937 through Q2 2008 based on 12-month trailing “as reported” earnings, plus estimates from Standard & Poor’s for earnings and P/E through 12/31/2009.

The 80-year average P/E based on 12-month trailing “as reported” earnings is about 15.75, compared to approximate P/E on that basis of about 23 as of 6/30/2008.

SPY was about $126 on 6/30/2008, and the long-term average P/E is about 24% below the P/E as of 6/30/2008.

A decline of 24% from $126 would create the $96 price point from the fundamental perspective.  Since SPY has already declined 11% since 6/30/2008, the remaining drop would be only 14% to reach $96.

The Bright Side of the Problem:

If we and Bernstein are both right, what a wonderful buying opportunity lies ahead.  If the S&P 500 goes down 14% from here (1106) to around 950 and then goes up to about 1270 twelve months from now, that would represent an approximate 34% gain.

The Half Full / Half Empty Side of the Problem:

We have read articles recently that suggest market rallies of around 38% in the year after a bear market bottom.  Well, that means that if we have a 38% gain likely after a bottom, we either need a lower bottom or a higher 12-month target.

Discretion may be the better part of valor in this case, by raising more cash even at these lower prices.

If you raise cash put it in either a Treasuries money market fund, or a money market fund that is enrolled in the US Treasuries money market value guarantee program.

Our managed accounts have been 70+% in cash since May.

Comments

[whidbey:]

Very interesting. My own work which is technical suggests that the S&P has further to go, but I have a problem with how you get a 34% recovery. Why such a leap? Just "historically"? I attempt to have a theory about what could drive recoveries and right now, I am without one. The mumbo jumbo about P/Es, historical v. projected (say 15 v 20) are just so much speculation as is the traditional 38% rally after a bear. This bear will leave marks on human minds, fear about the future. Will we throw experience to the wind?

2008 Oct 01 01:46 PM

[Andy Cole:]

Nice analysis.

2008 Oct 01 02:13 PM

[User 273289:]

The problem with technicals is that it never includes the human aspect, like the human greedy idiots who got us into this mess. These are different financial times we are living in with many records being broken and IMHO, this is not a time to put to much faith in technicals.

2008 Oct 01 04:01 PM