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Generational Dynamics Web Log for 9-May-2009
Stock market rally raises cautious, anxious hope among investors.

Web Log - May, 2009

Stock market rally raises cautious, anxious hope among investors.

The question is: Why is it happening, and how long will it last?

A couple of people have told me that they don't want to talk about the stock market rally, and they aren't even checking stock prices any more. From what I can tell, they're afraid that by checking the stock prices, they'll jinx the rally.

That's little different from what I hear on CNBC and Bloomberg tv. The financial statistics are universally disastrous, but no matter what they are, the tv analysts dig through them desperately to find some "green shoot" that will indicate that the worst is over.

There are two things you should keep in mind about the current rally:

A rally of this size in the midst of a calamitous stock market plunge is not unusual. As I wrote six weeks ago in "Enquiring minds want to know: How long will the rally last?", the stock market fell a full 90% from its peak in the years 1929-1932. During those three years, there were six rallies, including one 49% rally that lasted five months. So the current rally means nothing in terms of the overall direction of the market and the economy.

The predictions and analyses made on this web site are not based on just one or two months of data; they're based on long-term trends going back years and decades. I started writing in 2002 that we were headed for a new 1930s style Great Depression. That was based on the fact that the stock market was historically overpriced. (See "How to compute the 'real value' of the stock market.") The stock market is still overpriced by a factor of 150%. Price/earnings ratios have still been well above historical norms since 1995. The Law of Mean Reversion has not been repealed, and it means that a crash is coming with absolutely certainty.

Still, even though this rally is unimportant in terms of the longer term trend, we still want to know why it's occurring, and how long it will last. The answer to this question would have to be speculation, so let's speculate.

Based on what I've heard on CNBC and Bloomberg and elsewhere it appears to me that the pundits and analysts -- the ones who make fat commissions by investing other people's money -- have put together a "story" to justify continuing to collect their commissions.

I've heard several analysts/pundits make remarks about Q3 corporate earnings to the following effect: Investors expect Q3 earnings to grow substantially compared to last year.

It's worthwhile putting this in context. Ever since the credit crunch began in August, 2007, pundits have been predicting saying that "a bottom has been reached" on almost a daily basis. The slightest piece of good news is enough for the pundits to claim that the worst is over, and for web site readers to write to me and say, "See? You're wrong. The worst is over."

In particular, as earnings have fallen, quarter after quarter, pundits have been claiming that a revival of bubble-level earnings growth is only two quarters away. They make that claim every quarter. At the beginning of 2008, pundits were claiming that earnings would explode upward in the last two quarters. Now the same thing is happening in 2009.

So let's refer to the Standard & Poors earnings spreadsheet and see what the "official" analyst estimates are. Here's the table:

            Corporate earnings per share (EPS)
                 2008 (actual) 2009 (est)
          --   --------------- ----------
          Q1    $15.54         $7.32
          Q2    $12.86         $6.64
          Q3     $9.73         $7.46
          Q4   -$23.25         $7.09

Of the 2009 figures, the Q1 actuals are almost all in, so $7.32 is probably correct. The $6.64 estimate for Q2 is based on "guidance" provide by the companies along with their earnings reports, so these should be reasonably accurate.

After that, it's really guesswork, but even so, Q3 estimates are sharply lower than Q3 actuals for 2008.

If you add together the four quarterly figures for 2008, you get (-23.25 + 9.73 + 12.86 + 15.54) = $14.88, the total S&P 500 earnings per share (EPS) for the entire year 2008. At the current S&P 500 index of about 930, the current price/earnings ratio is thus 930/14.88 = 62.

As I wrote last month in "Wall Street Journal and Birinyi Associates are lying about P/E ratios," the official P/E is indeed around 60, and is being reported as such by Standard & Poors and by other mainstream financial firms. WSJ and Birinyi were reporting P/E = 13.09. The WSJ web site is now reporting 15.08, a mysterious figure that makes no more sense than the 13.09 figure.

Now let's turn that computation around, to estimate what we can expect from the stock market this year, based on the S&P figures.

If you add together the four quarterly estimates for 2009, you get (7.32 + 6.64 + 7.46 + 7.09) = $28.51. These earnings estimates are almost double the actuals for 2008, though still way below the $60-80 earnings per share typical of the bubble years.

At $28.51 earnings per share for 2009, if we assume the fantasy P/E ratio of 15 published by WSJ, then we get that the S&P 500 index this year will be (28.51 x 15) = 430, corresponding roughly to a Dow Industrials index of 4300. Thus, based on actual, official figures, we can expect the market this year to fall well below Dow 5000.

The Pollyannaish "story" being painted by the commission-earning brokers and analysts is based on general euphoria from the Obama administration's fiscal stimulus package, together with a few well-publicized cases where actual earnings turned out to be slightly less disastrous than analysts had previously predicted.

This "story" will serve the commission-earning brokers and analysts well, and will permit them to earn fat commissions for at least another quarter. When Q3 earnings start coming in, then they'll have to come up with a new "story" to continue earning commissions for another quarter. That will undoubtedly include a promise that earnings rebounds are still just two quarters in the future, and that you should buy stocks today to get in on the ground floor.

It's worth remembering, Dear Reader, that the same lethal combination of nihilistic Gen-Xers and incompetent Boomers that committed the fraud that led to the current financial crisis are the same people that you hear today on CNBC and Bloomberg tv or, for that matter, in the Obama administration. These include "brilliant" Nobel prize-winning economists like Krugman and Stiglitz. They're EXACTLY the same people, and their only motivations are to continuing collecting commissions and to make sure that someone else is blamed for their own crimes and their own complicity. None of them gives a sh-t about the ordinary investor. They're just in it for themselves.

So if you're happy with those people, and with their performance in the past, then you should continue believing them. After all, if you ever start to question their motives, then you might jinx the rally.

There's another very important aspect to all of this.

I heard an analyst on tv say that "capitulation hasn't occurred yet," referring to the fact that most money market funds haven't yet been sold off. According to this analyst, the bear market won't really end until we've seen true capitulation, including panicked selling of money market funds.

This refers to the hare-brained capitulation fallacy that I wrote about last year. Analysts used to talk about capitulation all the time last year, but they all expected it to have occurred long before now, so they've stopped talking about it. This analyst is saying that just because it hasn't occurred yet doesn't mean it won't occur, and that it has to occur for a "true" market rally to occur.

From the point of view of Generational Dynamics, this kind of panicked "capitulation" is important as well, but for a different reason and with different consequences.

From the point of view of Generational Dynamics, we're still waiting for a generational stock market crash, a huge, massive panicked selloff that will be remembered for decades as "the day the stock market crashed."

At first this will appear to be the "capitulation" that pundits have been hoping for. But it will go far deeper than expected, and it won't signal a new bubble stock market. Instead, the stock market will continue to fall, just as it did in the 1929-1932 period.

In August 2007 I posted the article "The nightmare is finally beginning," expecting the crash to occur within a few weeks. Instead, the Fed and Treasury have found a way to use one "liquidity injection" after another to prop up some financial institution, in order to head off a chain reaction.

Throughout all this time, there was one statistic that I could count on to predict where the market was going in the short range: The P/E ratio -- I mean the "real" P/E ratio, as shown in the chart on the bottom of the home page of this web site. Here's a recent edition:

S&P 500 Price/Earnings ratio and S&P 500-stock Index as of 17-Apr-2009. <font face=Arial size=-2>(Source: MarketGauge ® by DataView, LLC)</font>

S&P 500 Price/Earnings ratio and S&P 500-stock Index as of 17-Apr-2009. (Source: MarketGauge ® by DataView, LLC)

If you look at the far right side of this chart, where the red circle is, you can see a huge spike in the last weeks, sending the P/E ratio off the chart, to around 60.

As you can see from this chart, the P/E ratio stayed at 18 for almost 4 years, from which I inferred that computerized buy/sell programs were programmed to maintain that valuation. Not that there was some conspiracy going on, but that they had all been programmed with roughly the same algorithms, one of which was to honor the valuation of 18.

A year ago, valuations started rising into the mid-20s, and I was expecting them to fall to 18 again -- and they did in September of last year. That made sense to me.

But I never, NEVER dreamed that what's happening now could happen -- starting in January, as Q4's negative earnings were coming out, the P/E ratio indexes shot up to 60, and then the whole fabric of lying and deception began, as I described in "Wall Street Journal and Birinyi Associates are lying about P/E ratios."

What I infer is this: That this change has caused all the buy/sell programs to be reprogrammed to ignore the real P/E and use the Ouija board version computed by Birinyi Associates and published by WSJ. This was done by brokerage firms to protect their commissions, so that they could continue suckering ordinary investors.

This insanity is so great that it's hard for the mind to grasp. The way I look at it is that it's like stretching a rubber band to its limit, and when it snaps back, it will snap back much faster and harder than it would have otherwise.

Stein's Law: If something cannot go on forever, then it won't.

I know I keep saying this, but I just can't believe what's going on in Washington and on Wall Street. Even as cynical as I am about the lethal combination of Gen-Xers and Boomers, there is absolutely nothing in my experience that prepares me for this and allows it to make sense to me. If this were happening in a movie, I could enjoy it. But in real life, things are spinning so rapidly out of control that it makes me literally dizzy and sick when I think about it.

And so, Dear Reader, if you plan to stay in the stock market because your assets had lost over 50% of their peak value, and now are down only 40% of their peak value, then let me assure you that this current rally is a "bear market rally." It is nothing unusual in times of severe market plunges, and it means nothing in the longer term. Furthermore, P/E ratios are still astronomically high, and have been far above historical averages since 1995. Much worse is yet to come.

(Comments: For reader comments, questions and discussion, see the Financial Topics thread of the Generational Dynamics forum. Read the entire thread for discussions on how to protect your money.) (9-May-2009) Permanent Link
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Generational Dynamics Web Log for 9-May-2009 Stock market rally raises cautious, anxious hope among investors.

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Generational Dynamics Web Log for 9-May-2009
Stock market rally raises cautious, anxious hope among investors.