Saturday, April 18, 2009

Is There Something About 40, Or 39 Perhaps?

Bloomberg featured an article on April 16 that bear fund manager David Tice believes the S&P 500 may fall
to 325, even though the current rally in his estimation may still climb to 1000 “before faltering.”

The basis of Tice’s argument centers around earnings. Earnings is a big concern as Standard and Poor’s are
forecasting ttm earnings by end of Q3 09 to be roughly in the $15-$20. SP500 earnings are expected to slide
until Obama’s fiscal stimulus for 2010 kicks in gear beginning Q 4 09. At the moment, Bloomberg’s Survey
of analyst forecasts believe the SP500 will earn $47.45 in 2009.

“Stocks are overpriced in terms of earnings,” he said in a Bloomberg Television interview.

“We are closing down factories and retailers and businesses all over the place. How in the
world are earnings going to stabilize? We just don’t see it.” Companies in the S&P 500
trade at 1.9 times their liquidation value, according to data compiled by Bloomberg. Tice
said that ratio may fall to between 1 and 0.5. “I’ve never been more confident that this
market will fall back to at least book value,” Tice said.

On the flipside of Tice’s confident outlook that the “stock market will fall back to at least book
value” we have Ken Fisher contending that stocks are cheap “compared to long term interest rates”
and that a broad market rally has begun that will drive the SP 500 “as much as 70% above its
March lows.” 70% above the March 666 lows is 1132. Fisher also told Bloomberg News at the end
of March 2007, “I’m on the wildly optimistic side of things.”

Fisher’s bias is to err on the side of optimism, while Tice prefers to err on the side of pessimism.
Tice is thus calling for a multiple contraction or compression, while Fisher is calling for a multiple
expansion. What we know about the earnings model is that since the 1920s, the stock market is
generally considered overvalued above 20 and undervalued below 10 with the exception of the
past 20 years. During the past twenty years, the stock market has enjoyed a multiple expansion that
pushed it well above 20 for a long period of time. But generally, over 20 is expensive, under 10 is
cheap and generally the median p/e is roughly 15-16.

The P/E model is a moving target, there are too many parts. This is one of its primary weaknesses
in using it for modeling purposes. Still, it is widely considered. Thus, if we loosely assume
Bloomberg’s survey will be reasonably accurate and we round earnings in 2009 up to $50, the
SP500 would be considered expensive above 1000, cheap below 500, and fairly valued around
750. The 2002 yr low is 767 and the 2008 year low is 739, roughly speaking 750 is a huge
benchmark regardless of whether the stock market is fairly valued or not. As investors and traders,
we do not give a hoot about “fair valuations.” That euphemism makes no sense at all. The only
relevant euphemism for traders and investors is identifying where market participants are
extremely optimistic or excessively pessimistic, ala Benjamin Graham. Fishers forecast of 1132
could be said to be extremely optimistic and Tice’s forecast of 325 excessively pessimistic.

While we grant that the stock market could go higher yet in Q2 09, as does Tice, based on the
earnings valuation model, the SP500 is closer to being a bit rich rather than a bit cheap. Worse yet,
the stock market rally since the March 6 low has always seemed artificial to us, based on wisps of
fluff from the banksters. Their great achievements in Q1 were to eliminate FV accounting so they
can mark their assets according to whatever fictitious model they deem is appropriate using their
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“significant judgment;” catch a tailwind of profits derived from their “fixed income trading;” wider
margins (read gauging/excessive fees) due to less competition; and to collect their one-time
counterparty profits from their AIG CDS contracts funded by taxpayers. The clog in the financial
system persists as a result of too much credit creation from the previous boom. No matter what
Geithner does in May with his PPIP program to further defraud taxpayers and set artificially high
marks for toxic assets, the country as a whole suffers from over-indebtedness. This is a direct result
from reckless credit creation. Now, banks don’t want to lend.

Even if money weren’t tight and banksters were willing to lend again, borrowers who weren’t
worth a cent two years ago and now owe two million dollars are in no mood to borrow.

The engine driving this stock market rally off the March 09 lows appears fatally flawed. From this
perspective, it is really a matter of when and where it stalls out in Q2 09, or when the fantasy of
“green shoots” give way to the “real weeds” and harsh realities of the real economy. As FT’s
Willem Buiter said it, those “green shoots” Bernanke sees are really just “weeds growing through
the rubble in the ruins of the global economy.”

Given the foregoing, we are compelled to side with David Tice’s view. We might be going a little
higher near term, but eventually, the trend is extremely bearish for the stock market and
unfortunately we are going to have to look back down at some point. And that is the whole purpose
of this article, to look back down into the abyss and ask ourselves how low can the stock market
go? The only thing that would make me change my mind about the direction of the stock market
shifting from bear to bull would be to see genuine price discovery in those non-performing or
otherwise decaying assets being held by the banksters. This would involve a true resolution to the
financial system, not the artificial resolution being foisted upon us by the govt. A true resolution
would at the least have to involve putting Citi into receivership, possibly Bank of America too. In
such a case, I am afraid Fisher’s 1132 target would be far too low! The crisis of confidence would
simply disappear and go bye-bye. Euphoria and elation and relief would wash over investors. It
would be a huge event.

Market Numerology and the Significance of 39 and 40

As a student of the past 100 years of the US stock market, one of the fun and interesting exercises
to study is the long term time and price history of the Dow Jones and SP500. This knowledge
wont’ make you a dime, per se, but what we find are some very interesting things that come up
with the numbers 39 and 40 and multiples thereof.

For instance 39 x 10 is 390. The 1929 high happens to be 386, or rounded 390. Three years later
the Dow Jones bottoms at 40.5 in July 1932 and 40.5 years after July 1932, the Dow Jones tops
again in Jan 1973.

Two times 39 is 78. The Dow Jones topped in 2007 78 years after the 1929 stock market peak.
Three times 39 is 117. The Dow Jones peak in 2000 was 11750 or roughly 300x39. Four times 39
is 156, and four times 40 is 160. The SP500 in 2000 was 1574, and the SP500 high in 2007 was
1586. The SP500 stalled out at 40 x 40 or forty times itself.

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The number 40 harkens back to biblical numerology, consider the biblical meme of forty days and
forty nights. We shall leave the biblical numerology to the biblical scholars.

When we look at the quarterly Dow Jones chart going back to 1900, it behooves us to consider
where the economy is now and where the Dow Jones is now. It is safe to say the economy is in a
once in a generation or multi-generational fix.

Market participants will want to note that the generational 30 year moving average supported the
Dow Jones in 1974 and 1982. To wit, if the Dow Jones falls to its 30 year moving average now
sloping into 5600, you just might want to sit up and take notice. This could be a compelling time to
consider long term investing. Then again, if the economy is in a once in a lifetime rut, we may find
the Dow Jones needs to test its 50 to 80 year old trendline now sloping into of all numbers 4000.
Now, I am not prognosticating the Dow fall to 5600 or 4000, but, market participants should be

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keenly aware that our economy is at least as every bit as bad as it was in the 1970’s, or worse. A
reversion to the average price of the last 30 years should not come as a surprise to anyone

But what about David Tice’s 325 target for the SP500 in this kind of economy? To answer that
question, we have to turn our attention over to the SP500 charts. Below we consider the quarterly
and weekly. To begin, we note the 1957 yr low was 39, and that the 2009 year low to date is 666,
the mark of the beast strangely enough. Perhaps we should consult a biblical scholar after all to
discern the significance of these things. Intriguingly, the SP cash quarterly chart bottomed not just
at 666, but also just above its 30 year moving average at 660.

The long term quarterly SP500 cash chart shows that a reversion to the 50 to 80 year trend would
imply a test of roughly 570 in 2009-2010. If that raggedy old trendline did not hold, we could see a
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flush to that old bull resistance line (1929-1973) that will be sloping into 390-400 in the next few
years. The extended target would be the Great Depression 1932-1937 support line sloping into the
1987 high at 337 in the coming years. That is roughly the “David Tice” 325 target. The trouble
with the longer term charts is they give you such a terribly big perspective.

It is helpful to zoom in on the shorter term timeframes. Certain nuances come into focus that we
can not see looking at 80 years of price data. By zooming into the weekly chart, we see the
relevance of the number 39 taking on added significance in the SP500 these past few decades.

The weekly SP cash chart above shows the stock market pausing just above 1170 in 1998 before
making its final ascent to roughly 1560 to years later. The 2000-2002 bear market bottomed at

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roughly 780, and along the way to 780, it failed to breach 1170 in early 2002. These are levels that
are all related to multiples of 39. In the post 9/11 rally into early 2002 the stock market failed to
breach its one year average. The one year average is sloping into the 1050s as I write which is far
below Fisher’s 1132 target. In an economy that is “getting worse, only more slowly” it is difficult
if not impossible to see this market breaching its one year average. In an economy getting worse
only more slowly, a retest of the 740-780 area should most be revisited. More likely, a retest of the
1996 high at 681 is surely expected, and quite possibly the 1996 low at 605-ish. Should the
economy get worse only more rapidly, the SP500 could give back all those stellar gains in 1995
and reach for those 1991-1992 levels that vibrated off roughly off 390. I am not forecasting 390 at
all as a target. I am just noting its previous significance in 1991-1992 and its potential significance
is this global recession morphs into a Global Depression.

The one thing the economy does have going for it as we enter Q2 09, is that things are getting
worse but only more slowly and that could bode well to stabilize the stock market. If things get
worse more quickly at some point, then yes, worst case scenarios would project the SP500 to
roughly 390-400, as actual earnings would be far worse than the expected estimates of $47 for
2009.