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Sunday, February 5, 2012

Market Thought... re-evaluation

A few weeks ago, the World Bank lowered their global GDP outlook to 2.5%.  IMO, a 2.5% global GDP is sufficient to produce about a 5% EPS growth on the SP500.   Since then we got some information that could challenge the lowered thesis.

1. Stronger global PMIs (But the stronger trend, since Oct, is more telling.)

2. strong US Jobs number

3. CAT, during their conference call, said they are seeing stronger growth and projected a global GDP of 3.3%

Over the last few months, the market trailing PE was between 12.5 to around 13.  The huge instability caused by the Europeans rightfully caused this discount.  However, now we have a sense of stability.  That stability should continue as the ECB big guns are active.

A stable financial system combined with stronger economic data should allow for better global GDP growth.  This thought process should give more confidence to the lazy money managers who focus too much on 'top-down' analysis.  At the very least, this should translate to a market that trades with a better trailing PE. (Also, they tend to put a over reliance on copper, and copper looks to want to break-out here, which only adds to the argument.)

Here is my breakdown with conservatively assumed EPS growth, but with a better PE range between 13.3-14 (which is still below the historical average of 15).

Basically, the above is my market range expectations for the subsequent quarters.

Keep in mind, if the market decides to expand its PE, to a level prior to August 2011, many individual stocks will see multiple expansion.  One prime example of that is DIS.  DIS, like many others, had a higher trailing multiple prior to August, and has yet to recover despite stronger results last quarter and accelerated earnings growth.

At some point, the market needs to consolidate from the current overbought condition.  When that point comes is a bit tricky.  I am now waiting for the VIX to get to extreme lows with the below overlay.

A few potential catalysts for a consolidation include:

1. CDS gets activated for the Greek default.

2. Portugal starts restructuring talk that may also cause CDS to be due.

3. Chinese inflation may spook some. (They did not lower rates when expected, probably because their economy is doing better than expected, and that could lead to a higher CPI or PPI rate on Wed.)

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