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Friday, September 30, 2011

Market Thought... recession?

Who to you believe, Warren Buffett or leading economic indicators?

Leading indicators:

Or Warren Buffett:

As if we needed any more confusion in this market environment. Its obvious the queues are being taken by the leading indicators. After all, there has to be a reason why everyone is so negative.

I have been pretty vocal that certain indicator were skewed by the Fed's 'twist'.  Which begs the question, are the other leading indicators skewed too?  I do not know how ECRI models their leading indicators, but this is a very legitimate question.  The Fed's twist effectively destroyed global inflationary pressures by exaggerating the dollars rally. If the leading indicators in the ECRI index are sensitive to the dollar move, commodities or certain leading inflation metric, then it too maybe skewed by the twist.

Over the years, I have been pretty good at seeing slowdowns from hints and clues with my charts and combing web chatter.  No doubt we were seeing a stall before August, as the market was consolidating due to relatively poor US economic data and geopolitical issues.  But we are in a situation now where the markets already collapsed.  So lets assume our risk.

Lets assume EU and US austerity cause a no growth environment. Facilitating a very slow global GDP.  The big boys will value equities for zero growth, which will mean the SP500 will trade at its low end multiple, around 12ish.

Lets assume current SP500 earnings estimates for 2011 are too high (even though estimates have not come down). From $96 to $86. (All indication suggest this earnings season will be good. So I am assuming a 10% reduction within a 3 month period.  That is a lot.)

For the market multiple to stay at 12, and not the more normal 14-15, we have to assume no earnings growth next year. (A multiple of 12 assumes an SP500 eps of around $86 too.) Doing the math (12 x 86) give us an SP500 target of is 1032.  But even in times of recession, market multiples are higher. If we are to assume a multiple of 14, the SP500 would be near 1200.

Although companies are still doing better than expected, and see decent clarity for business activity, we must assume the worst case scenario.  The current 2011 and 2012 SP500 earnings estimates are about $100 and $110, drastically reducing them, and projecting no growth, we find ourselves in a situation where the market will be trading between 1032 and 1200.  This range is where we currently are and have been violently trading.

Equities are already pricing in a recession.

And is it just me, or does it feel like everyone is already betting that way? Suggesting the risk is to the upside.  Maybe I am an optimist, but I try to be a realist.

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