Was 666 the bottom? By now, practically everyone knows that the intra-day low we bounced from on Friday was our call for what the trough could possibly look like -- we had danced around this number for months but last reiterated it when the S&P 500 was hovering near 835 back in mid-February.
As we have said in the past, the S&P 500 index any moment in time is the construct of two numbers -- corporate earnings and the multiple that investors are willing to pay for that profit stream. We had been of the view that we could be at 666 by October under the caveat that a classic 12x recession trough multiple would be applied to a 2010 forward operating earnings forecast of $55.50.
But given that we are in March, and we still have to apply that multiple to 2009 earnings of $46, then we are talking about the prospect that we could actually see this market go as low a 550 before we hit bottom. That is not a forecast, but it is more than a remote possibility, in our view.
If we were to apply a blend of 2009 and 2010 earnings, we would be talking about a bottom of around 600. So in answer to the question whether 666 was an intermediate low or something more fundamental, at this stage, unless this recession is over by July, then in our view it simply cannot be that the bear market is over because bear markets end typically 4 months before the recession ends, or when we are two-thirds of the way through, take your pick.
This economic downturn began in December 2007; our internal compass now tells us that we are still barely halfway through, so conceivably, we may not be pulling out of the recession until we are well into 2010.
So with that in mind, it's hard to believe we are at the low unless our timing of the end to the recession is off base. That is always a possibility, but we simply don't see a light at the end of the economic tunnel just yet. We also have to respect the likelihood that the financials, which led the bear market by six months, will be the group that leads us out -- and considering that the S&P financials just hit a fresh 17-year low, we can say with some degree of confidence that the bottom to the overall market is probably at least six months away at this point.
One last item to consider is how bear markets like the one we are in have always ended -- they end when we break below what was universally perceived to have been the fundamental bear market low for the cycle, because that is the time that sentiment gets washed out once and for all.
For example, in the last cycle, the September 21st, 2001 low of 965 was widely viewed back then as having been the fundamental low, and when that low was broken on July 2nd, 2002, the S&P 500 sliced all the way down to 776 by October 9th like a hot knife through butter.
Go back to the early 1980s -- the 112 mark on September 25th, 1981 was supposed to hold. It didn't; it was shattered on February 22nd, 1982 and the ultimate low was turned in on August 12th of that year at 102. We went back five decades and found that in the five major markets over that span, all of them shared this pattern of having a low hold for a period of several months, and when that low was shattered, the S&P 500 on an average and median basis fell a further 20% until the real cycle low was achieved.
So 20% off that 752 closing low back on November 29th would imply 600 on the S&P 500 this time around or roughly another 10% downside from where we are today. Again, that is more of an observation than it is a forecast, and if there is a sprinkle of good news, it is that almost 95% of the bear market is over even if 600 is where we finally bottom out at.
Nicholas J. Shepard
International Equity Sales Trading,
Merrill Lynch, New York