Down, then up, then down again. How about that? I believe that the global risk markets will bottom sooner than people think, and that the time has come to compile a shopping list of investments to pick up on distressed days in the market.
I think that at the most extreme, the S&P 500 will bottom at 1,000 at the lowest from yesterday’s 1,123 close. More likely are important bottoms at the Fibonacci levels of 1,045 and 1,065. At 1,000, the index will be showing a 28% decline from the April 29 peak. The market multiple will have collapsed from 14 to 10 times earnings. That is against a 30 year range of 10-22. In other words, we will have discounted a full scale recession. Ten year Treasury bond yields are telling us the same with a 2.03% yield, against a 3.6% inflation rate.
The likelihood is that this recession is not going to happen. Virtually all the current economic data is consistent with the forecast I have maintained all year of 2%. Car sales show that the industry is recovering. Major exporters like Caterpillar and Freeport McMoran show the demand from emerging markets is booming. An enormous reconstruction package in Japan is just starting to kick in. Add all this together, there will be enough demand to assure 2% growth for the full year, which would represent a modest improvement from the first half.
Mind you, I am not proclaiming the birth of an entire new bull market. I believe that we put in the top for stock prices for this economic cycle on April 29 at 1,384, and it is unlikely that we see that print again. My best case scenario will be for a recovery of the 200 day moving average at 1,285. If we start this move off of a 1,000 bottom then there is room for a 28% move, certainly something worth taking a bite of.
What will be the drivers of such a move? In September, we will start releasing Q3 corporate earnings, which are likely to be buoyant. We will also start to see the traditional yearend liquidity push. Europe will hopefully go quite again, once the leadership returns from summer vacation. The icing on the cake would be any surprises from the Federal Reserve on the monetary front, as they did last year. All of this will pave the way a rise in risk assets everywhere that could last three to four months.
That gets us into 2012, when the real challenges reassert themselves. Very little about the presidential election is likely to be equity friendly. Arrest Ben Bernanke for treason? Really? Where’s the rally in that? Gale force headwinds on the demographic front start to kick in and the first baby boomers reach the age of 66 and dramatically pare back spending. Corporate earnings will then hit diminishing returns.
Real estate promises to take another leg down, possibly as much as 25%. This will put the banks through the meat grinder once more, but this time there will be more TARP. You can forget about getting any help from congress on the economy either. It all sounds like a replay of 1937 to me, when the government ended stimulus too soon, triggering a secondary great depression. This could all add up to a real crash of the 2008 variety, with declines of 50% or more on the menu.
So what I am proposing here is not an investment, but a trade. It assumes a dead cat bounce in PE multiple from 10 to only 12.8. Preserving your capital will be the name of the game, while pulling in what incremental trading income that you can.
How could I be wrong? If failing stock prices deliver a self-fulfilling prophesy. If this summer’s melt down in risk assets frighten consumers into paring back spending and corporations into backing off from capital investment, then my growth targets above will like high, and we are already in a recession. Call us “dead men walking.” It is also possible that structurally low growth is forcing a permanent downshifting of the market’s multiple range from 10-22 to 8-16. Then risk assets will begin plumbing far greater depths. This could also happen if any of the long list of structural negatives listed above accelerate. The only way to stay alive in these markets is to believe that all things are possible at all times.