Tuesday, June 23, 2009

Market decline was expected, but will it continue?

Since we mentioned that the market was up too high (weekend of 6/14), NASDAQ (IXIC) has declined 5%, while the Dow (DJI) and S&P 500 (GSPC) have declined approx. 6%. Such decline was driven by profit-taking (as the market shot up too high and too fast after the March lows) and finally a sense of reality regarding the housing market, unemployment and consumption.

We think there are some fundamentals that might push the market down further. For example, take a look at the GSPC P/E ratio for 2010. As of Monday's close, it stands at 23.6 (based on GSPC's GAAP earnings estimates). This figure represents a 0.8 PEG, which surprisingly, indicates GSPC being fairly valued at 893.

But the question is - is the GSPC 2010 consensus earnings growth estimate of 32%+ realistic? We don't think so, especially given the 2.0% consensus 2010 GDP growth. Average annual GDP growth after the last recession until 2007 was only 2.6% (1.6% for the first year after the recession), and that growth was debt driven, for which we have been paying the last 18 months (and likely longer). During the same period, average GSPC earnings growth was 21.0%. We are using the latest recession figures mainly because they more closely resemble the more purely consumption-driven economy. We note those figures are less favorable for the expansion years between the 1991 and 2001 recessions.

Given continuing deleveraging by households, significant decline in wealth and the not-yet-stabilized unemployment rate, all of which will keep consumption at low levels, we think a 32% earnings growth for 2010 is too optimistic. Assuming a more conservative, or realistic, 25% earnings growth in 2010, an 850 GSPC valuation (5% below Monday's close) could be more realistic. This also represents a PEG of 1.0.

From a technical standpoint, with GSPC closing below its 50-day and 200-day MA, it could go down to the 880 level, after which 850 could be next. The next few days could provide a clearer picture of whether or not GSPC will hit 850. The slope of the 50-day moving average is on the brink of turning negative, which will be bad news. We don't believe the market will get back to the March lows, but the correction, we believe, is not yet complete.

Although many think the market could turn around tomorrow, after Monday's big dip, we note that there is one driver tomorrow that may push the market further down - President Obama's press conference on the economy. Even though the market has shot up nicely during half of his YTD tenure, it hasn't responded positively too often when he's discussed the economy and his regulations. Disappointment in this week's treasury auctions could also negatively impact the market.

No comments:

Post a Comment