Analyst Predicts Possible 1,300 S&P at End of 2009

Harvey Firestone, President of Firestone Tire & Rubber Co., stated…America is on [the] eve of greater prosperity than known the past ten years.
--The Wall Street Journal, August 19, 1930

Today, Bloomberg.com reported:

Global stocks will withstand a “full-blown” recession and surge in 2009 as cheap valuations and efforts by governments to restore confidence in the financial system lure investors back to equities, UBS AG said.

The Standard & Poor’s 500 Index, which tumbled 42 percent to 848.81 this year, may rally 53 percent to 1,300 by the end of 2009, David Bianco wrote in a note dated yesterday. The New York-based strategist, who a year ago predicted a 2008 advance of 16 percent for the S&P 500, is now forecasting a gain that would exceed the index’s best annual performance on record.

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A look at the historic experience suggests that a rally to 1,300 by the end of 2009 by the S&P 500 index is not very likely.

First, it should be noted that stocks usually bottom out 3-6 months before the end of a recession. Assuming the present recession lasts until the start of 2009 Q3, the stock market’s bottom would probably occur sometime early next year. A more prolonged recession would suggest a later bottom.

Second, a look at past recessions argues against the kind of rally Mr. Bianco is indicating could occur. Assuming that the 11/20 close of 752.44 proves to be the bottom, and past-recession experience suggests it probably won’t be the bottom, the following is the implied close (change with respect to the 752.44 figure) for the S&P 500 13 months and 10 days after the market bottomed out:

1960-61 Recession: 1,036.84
1969-70 Recession: 1,083.54
1980 Recession: 1,099.91
1981-82 Recession: 1,247.16
1990-91 Recession: 1,023.69
2001 Recession: 1,009.81

Mean: 1,083.49
Median: 1,091.73

The 1981-82 recession followed closely on the heels of a short but sharp recession in 1980. The 1981-82 recession resulted from an extended period of extremely tight monetary policy engineered by the Federal Reserve under Chairman Paul Volcker aimed at breaking the back of double-digit inflation. No asset bubbles were involved. The 2001 recession coincided with the bursting of the dot com asset bubble. With respect to annualized growth in real GDP, such growth came to 4.3% during the period in question following the bottoming of the stock market. In 2001, that growth amounted to just 0.6%.

Third, when it comes to post-asset bubble recessions, those associated with collapsed real estate bubbles tend to be longer and more severe than those that follow the collapse of equities bubbles. In part, the worse outcome following housing bubbles deals with the amount of debt involved and the damage that is incurred on financial institutions’ balance sheets. Typically, a credit crunch follows. Occasionally, there is systemic financial system failure, the onset of deflation, and or a currency crisis.

Fourth, assuming that the current recession rivals the 1973-75 and 1981-82 recessions in magnitude and duration, one could expect the earnings per share for the companies that comprise the S&P 500 to come to $70 and $77 next year. With a price-earnings (PE) ratio of 15, the implied value of the S&P 500 would fall between 1,050 and 1,155. That would be consistent with the mean and median figures cited earlier. However, it should be noted at the time the 1973-75 and 1981-82 recessions ended, the PE ratio was 11.7 in 1975 and 10.2 in 1982. In 1976, the PE ratio stood at 11.0 and in 1983 it had risen to 12.4. A PE ratio around 12 would leave the S&P 500 below 1,000 by year-end, assuming the earnings per share fall to levels consistent with the 1973-75 and 1981-82 recessions.

Finally, how key factors play out could determine whether the magnitude and duration of the current recession and its impact on corporate profits in 2009. Those factors include:

• The continuing evolution of the economic challenges, likely impacting commercial real estate and consumer credit.
• Long-term deleveraging that reduces the role of the consumer in the overall economy. Currency, real personal consumption expenditures account for just over 70% of GDP. That figure could slowly decline into the middle- or upper-60s.
• Possible emergence of deflation. Given U.S. debt levels, particularly mortgage-related debt, which exceeds U.S. GDP, debt-deflation could have a devastating impact.
• Possible rapid return of inflation once the economy begins to revive.
• Impact of rapidly rising U.S. debt levels. If foreign capital inflows slow or even reverse, a currency crisis could unfold.
• Possible geopolitical shocks that could complicate or exacerbate the nation's challenges.

In the end, it is not implausible that the suggestion of a potential record rally by the S&P 500 next year is little more than a swing for the fences after 2008’s spectacular miss. Unfortunately, historic experience concerning recessions and historic experience pertaining to the aftermath of collapsed asset bubbles, suggests that a strikeout on a 1,300 S&P 500 by the end of 2009 is more likely than a homerun.

One month into 2009, U.S. stocks took another beating. The S&P 500 ended the month at 825.88, an 8.6% decline from the end of December.

At this time, the macroeconomic environment continues to be defined by a number of factors:

• Long-term deleveraging that reduces the role of the consumer in the overall economy. Personal spending fell another 1% in December.
• At this time, a fresh shock may be working its way through the U.S. economy. U.S. oil consumption has begun to fall again. The money multiplier has dropped below 1.00, leaving much of the extroardinary monetary policy response effectively bottled up.
• Possible emergence of deflation. Given U.S. debt levels, particularly mortgage-related debt, which exceeds U.S. GDP, debt-deflation could have a devastating impact.
• Rapidly rising U.S. debt levels. Fresh expenditures of $1 trillion or more could be enacted to address financial system dysfunction and to provide an economic stimulus. Enormous borrowing by the U.S., European Union, and Japan could distort global capital markets, absorbing capital that might otherwise flow into developing countries. That development could lead to unrest in such countries and perhaps the emergence of currency crises in parts of the developing world.
• Global trade activity has begun to shrink rapidly. At the same time, whispers of protectionism have surfaced. A trade war, even a modest tit-for-tat response, could deepen an already substantial synchronized global recession.
• Possible geopolitical shocks could emerge to complicate or exacerbate the nation's challenges.

Finally, the bottom for U.S. stocks may yet lie ahead before a more persistent recovery in stock prices could develop later in the year. Such a recovery is not completely certain given the possible shocks that might yet impact the U.S. and global economies.

Post-World War II recessions have seen stocks typically bottom out 3-6 months prior to the end of the recession (70% of recessions saw stocks bottom out 3-6 months before the end of the recession; 20% saw stocks bottom out < 3 months before the end of the recession; 10% saw stocks bottom out > 6 months before the end of the recession).

In sum, after the first month of 2009, the data continue to argue strongly against the S&P 500's reaching 1,300 by year-end.

Bet he was smoking crack.

Author Ship

"Author Ship"

donsutherland1,

Did you draft the content in the OP? Or copy it directly from some other source?

Re: Author Ship

Monk-Eye said:

"Author Ship"

donsutherland1,

Did you draft the content in the OP? Or copy it directly from some other source?

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I wrote it.

One thing I noticed missing is that there is a distinct possibility that the S&P's projected number will be that high for artificial reasons.

Big bath - Wikipedia, the free encyclopedia

Everyone's taking their charge offs now so when the economy's back up, they will project significently higher returns as they've shed all of their junk.

A quick update...

With the S&P 500 having closed at 696.33 yesterday, its lowest close since October 10, 1996 when the S&P ended trading at 694.61, that index would need to rise an unprecedented 86.7% in the remaining nearly 10 months of this year to reach 1,300. Such an outcome is extremely unlikely given underlying fundamentals and the historic experience following the collapse of asset bubbles.

Another quick look back at a widely-publicized prediction from last year.

FWIW, the S&P 500 ended 2009 at 1,115.10.

If one had relied on the historic experience for an idea of where the market might end up, using the seven previous recessions, one would have come up with the following mean and median figures:

Mean: 1,083.49
Median: 1,091.73

From the actual outcome, one would have been off by 2%-3%. For the extreme figures (lowest and highest implied closes) for the six recessions, one would have been off by around 10.5%. The prediction of 1,300 was off by 14%.

In short, a grounding in the historical experience provided good insight when assessing where the S&P 500 would end 2009. In the larger scheme of things, this is just another example that argues for a greater emphasis on historic experience vis-a-vis other approaches when one is trying to gain a reasonable understanding of risk.

obvious Child said:

One thing I noticed missing is that there is a distinct possibility that the S&P's projected number will be that high for artificial reasons.

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Exactly what I was thinking.

Perhaps you could define "artificial reasons" for us?

For example, look at the housing refund we did. It artificially stimulated demand for housing. Look at what the numbers will be next month now that the refund is gone. That is the real demand. Demand with the refund minus demand without the refund is the artificial demand.

phattonez said:

For example, look at the housing refund we did. It artificially stimulated demand for housing. Look at what the numbers will be next month now that the refund is gone. That is the real demand. Demand with the refund minus demand without the refund is the artificial demand.

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At the risk of sounding like I'm arguing semantics, I greatly prefer describing the temporary shift in the demand curve resulting from the housing tax credit as exactly that: a temporary shift in the demand curve. There was nothing "artificial" about it. It was real; it happened. Temporary? Yes. Artificial? No.

But, admittedly, that is just a personal preference.

As for the impact of artificial or temporary (take your pick) demand on stock prices: to assume that the market in it's aggregate wisdom doesn't realize that the stimulus program (in its various forms and flavors) isn't built into prices via expectations is naive. There certainly isn't anything secret or unknown about any of these programs. Whatever the various forecasters are projecting for the various indexes, expectations of the impact of the stimulus programs are certainly incorporated.

Now, if you believe that their assumptions re: the ex-post position of the demand curve, are nuts, that's another thing entirely!

Many believe, though, that the effects of the stimulus will be permanent. They believe that the stimulus will "correct" the economy. If you're wrong about that, and investors don't account for it, then you'll have artificially high stock values.

phattonez said:

Many believe, though, that the effects of the stimulus will be permanent. They believe that the stimulus will "correct" the economy. If you're wrong about that, and investors don't account for it, then you'll have artificially high stock values.

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The point of stimulus is not to "correct" the economy, but to "ease the blow".

Yesterday, I noted that using the historical data from the past 7 recessions (in December 2008 when this thread was started) would have led to an estimated end-of-2009 value for the S&P 500 that wouund up off by 2%-3%.

Now that the U.S. has moved through the recession and is in the midst of a cyclical rebound (albeit with continuing headwinds and some significant risks), what might the historical data suggest about the closing price for the end of 2010?

Three points are relevant:

1) Mean value: 961.25; Median value: 1,019.49

2) Two deepest recessions: 1973-75 (-3.2% decline in real GDP): 1,102.26; 1981-82 (-2.9% decline in real GDP): 1,019.49; Mean for those recessions: 1,060.87

3) There is large downside risk e.g., if a double-dip were to occur e.g., as followed the 1980 recession.

Some assumptions looking ahead to be coupled with the historical experience (greater weight being given to the deeper recessions, particularly 1973-75):

1) Moderate growth for the rest of this year with real GDP expansion of around +3.0% or so for the year as a whole.

2) Financial system fragility persists though it is not as severe or widespread as it was last year. Hence, risk aversion could remain elevated and credit expansion is not likely to be too aggressive through the remainder of this year.

3) Sovereign debt issues are a growing concerning given post-recession public debt burdens. A possible U.S. debt crisis remains a medium-term risk, not something that is likely this year.

4) China's potential housing bubble probably would not burst this year, though China's rate of growth could decelerate in the second half of this year. That would amplify the risk of a possible housing burst in the future, but not this year.

5) The U.S. will not launch military operations against Iran's nuclear facilities sparking adverse geopolitical consequences e.g., an energy price shock; Tensions on the Korean peninsula will remain elevated but war likely won't erupt. The North has exercised brinkmanship in the past without resorting to all-out war. The South would only respond in self-defense.

The combination of the historic experience and assumptions might imply a closing price somewhere in the vicinity of 1,075 +/- 100 points for the S&P 500 at the end of this year. Downside risk is probably greater than upside risk.

For purposes of comparison, this year's highest and lowest closing prices to date have been:

Highest: 1,217.28, April 23
Lowest: 1,056.74, February 8

phattonez said:

Many believe, though, that the effects of the stimulus will be permanent. They believe that the stimulus will "correct" the economy. If you're wrong about that, and investors don't account for it, then you'll have artificially high stock values.

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Interesting bit from Fannie Mae chief economist, as reported by Calculated Risk:

"The federal homebuyer tax credit shifted demand in the U.S. housing market without having a lasting impact on prices, according to Douglas Duncan, chief economist of Fannie Mae, the largest mortgage financier.

"Temporary tax credits change behavior temporarily,” Duncan said today at a National Association of Real Estate Editors conference in Austin, Texas. “It’s simply shifted demand forward...”

“It actually created some price appreciation that’s not supportable long term,” Duncan said of the tax credit."

BTW, if you haven't been there before, Calculated Risk is recommended. Very often quite thoughtful.

Yesterday, CNBC reported that Goldman Sachs analyst Abby Joseph Cohen predicted that the S&P 500 would end the year around 1,250. The key premise of her argument was that the markets had already priced in “some less than pleasant news.” In short, a rising tide of corporate profits, a deceleration of growth, but not a recession, should allow for a spurt in stock prices over the next six months.

However, a look at the historic experience concerning the past 7 recessions would suggest that the 1,250 price target is probably too aggressive. Instead a close around 1,075 +/- 100 points would be more likely and there would probably be somewhat more downside risk than upside risk.

As noted earlier in this thread, a number of factors continue to define the risk environment:

1) Moderate growth for the rest of this year with real GDP expansion of around +3.0% or so for the year as a whole.

2) Financial system fragility persists though it is not as severe or widespread as it was last year. Hence, risk aversion could remain elevated and credit expansion is not likely to be too aggressive through the remainder of this year.

3) Sovereign debt issues are a growing concerning given post-recession public debt burdens. A possible U.S. debt crisis remains a medium-term risk, not something that is likely this year.

4) China's potential housing bubble probably would not burst this year, though China's rate of growth could decelerate in the second half of this year. That would amplify the risk of a possible housing burst in the future, but not this year.

5) The U.S. will not launch military operations against Iran's nuclear facilities sparking adverse geopolitical consequences e.g., an energy price shock; Tensions on the Korean peninsula will remain elevated but war likely won't erupt. The North has exercised brinkmanship in the past without resorting to all-out war. The South would only respond in self-defense.

On the first point, Ms. Cohen’s assessment is not in disagreement. In fact, she notes, “…we see businesses are investing again. They’re buying that productivity-enhancing equipment for their workers.” In other words, at least in the near-term, businesses will be looking to boost productivity of their existing workforces rather than aggressively increasing hiring. If so, that means consumer demand will not increase at more robust rates, credit could continue to recede or grow at a very low level, the housing market will likely remain shallow, and growth in consumer spending will remain modest. Until the U.S. economy becomes broader-based, in other words, less dependent on consumer spending, that outlook suggest only a moderate-paced recovery lies ahead for the near-term. In such a context, overseas shocks could further undermine the growth rate and the margin for error could be relatively small.

On the third point, Europe is still navigating the market turbulence associated with sovereign debt issues. A decided turn toward fiscal consolidation has been getting underway. At the same time, it remains to be seen whether Greece will be able to deliver the desired budget deficit reductions under its current austerity plan. Historic evidence concerning prospects for success are decidedly mixed. One cannot rule out a fresh eruption of concerns about Greece later this year, particularly if the recession there proves sharper than anticipated and Greece’s budget woes are worse than expected. Some spillovers would be possible under such a scenario.

On the fifth point, today Bloomberg.com reported:

The Conference Board’s leading economic index for China, which overtook Germany as the world’s biggest exporter last year, rose 0.3 percent in April, less than the 1.7 percent reported June 15. The data damaged investor confidence amid concern a Labor Department report July 2 will show the U.S. lost jobs for the first time since December while European banks’ balance sheets come under renewed scrutiny.

Finally, it should be noted that market discounting is not prescient. In fact, there is academic literature that suggests that markets often expect the near future to look not very different from the present. Hence, “surprises” continually occur and markets often swing to excess in either direction as psychology trumps fundamentals during those swings. In short, historic experience concerning the previous recessions may offer a better idea as to where things will end up. If so, a range-bound situation with perhaps somewhat more downside risk could define the markets’ course during the remainder of the year.

Adding to the point about historic experience offering a less rosy picture than Ms. Cohen, CNBC provided the following snippet concerning the S&P 500:

S&P 500 [.SPX 1041.29 -33.28 (-3.1%) ]

-Since 1951, the S&P 500 has fallen in the first half about 34% of the time (20 times over the past 59 years)
-86% of the time since 1951, the direction of the S&P 500 for the full year has correlated with the direction at the end of the first half
-Only 6 times since 1951 has the S&P 500 finished the full year up after starting out the year with a first half decline
-After turning in a first half decline, the S&P 500 has followed up with a second half gain 50% of the time

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News Headlines

The S&P broke out from a head and shoulders pattern.

Let me pull out my crystal ball. I think it will pull back to 1050 in the next week or 2 and then its going to around 950, finding support, then falling to a low of 875. Then it will probably tick back up to 950 within 6 months and form a new uptrend.

I think around 1000 would be a good end of year estimate, without doing any sort of hard core analysis. I think after dropping below a 1000 it will spend quite a bit of time hopping just above or below that mark as the markets always seem to do. Actually lets just say it, first day of trading in 2011 will close at $1042, bookmark it.

drz-400 said:

The S&P broke out from a head and shoulders pattern.

Let me pull out my crystal ball. I think it will pull back to 1050 in the next week or 2 and then its going to around 950, finding support, then falling to a low of 875. Then it will probably tick back up to 950 within 6 months and form a new uptrend.

I think around 1000 would be a good end of year estimate, without doing any sort of hard core analysis. I think after dropping below a 1000 it will spend quite a bit of time hopping just above or below that mark as the markets always seem to do. Actually lets just say it, first day of trading in 2011 will close at $1042, bookmark it.

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The market is already below your guesstimate of 1050. So are you calling for a bounce to 1050?

washunut said:

The market is already below your guesstimate of 1050. So are you calling for a bounce to 1050?

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Ya, it will pull back up to 1050 (looking at closing prices) before begining its downfall in earnest to 950, then it will move sideways, then fall to 875, then it will move back up to 950 ish and back up to 1042 by jan 1.

These are purely scientific estimates.

I am pretty sure it is not going above 1,050 for a while though.

drz-400 said:

Ya, it will pull back up to 1050 (looking at closing prices) before begining its downfall in earnest to 950, then it will move sideways, then fall to 875, then it will move back up to 950 ish and back up to 1042 by jan 1.

These are purely scientific estimates.

I am pretty sure it is not going above 1,050 for a while though.

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OK let's see what happens. To get to 1050 it would have to rise about 300 dow points.

It went a little higher than I thought (1060), but there's an exhaustion gap in the major indexes today. Downhill from here I believe.

Toward the end of May, I had noted (Msg. #15):

The combination of the historic experience and assumptions might imply a closing price somewhere in the vicinity of 1,075 +/- 100 points for the S&P 500 at the end of this year. Downside risk is probably greater than upside risk.

Three months later, I have little change to that thinking. I do believe that the emphasis on downside risk was probably the correct way to go, as I now suspect 2010 real GDP growth may come in around 2.7% vs. the 3.0% I had previously assumed.

As far as the market environment goes, my present thinking is as follows:

• The stock market is awakening to the reality that its dream of a “V-shaped” recovery, which had been reflected in market prices from time to time, was only a dream. Reality is less attractive. Moreover, against historic valuations, current prices remain higher than the historic norm.

• Although the massive rescue package in Europe has addressed liquidity concerns relating to Greece, and some other highly indebted countries, it does not address solvency issues. Very early evidence suggests that Greece may be starting to fall behind in terms of its deficit reduction effort.

• Financial system fragility persists. As a result, growth in the supply of consumer credit will remain restrained. Household de-leveraging will continue to restrain demand for consumer credit, as well. Hence personal consumption expenditures will grow more slowly than they had in past recoveries.

• With personal consumption expenditures likely to grow at a restrained rate, businesses will remain abnormally cautious until they see visible signs that aggregate demand is picking up and the increase is sustained. Hence, even excluding structural unemployment, the unemployment rate is likely to remain high through the rest of this year and next year.

• Core inflation is likely to remain subdued through at least next year.

• Given the combination of a fragile financial system, low inflation, slow credit growth, and high unemployment, the Fed will very likely leave interest rates unchanged through this year and likely will leave them unchanged through next year.

• Geopolitically, no military operations against Iran are likely this year.

Needless to say, with each period sustained rise in stocks, momentum-riding bulls will proclaim confirmation of an ongoing bull market. With each periodic sustained retreat, momentum-riding bears will proclaim the onset of an even deeper dive to come. What do both momentum riding groups have in common? Each is stubbornly attached to its existing bullish or bearish beliefs. Each selectively cites information that bolsters its preferred view while ignoring contradictory information. Each ignores historic experience. Each also knows that at the end of the year, the business media will not tally up and verify each side’s myriad momentum-driven forecasts.

If David Rosenberg has it right, 1050 will be but a fond memory:

Positive gross domestic product readings and other mildly hopeful signs are masking an ugly truth: The US economy is in a 1930s-style Depression, Gluskin Sheff economist David Rosenberg said Tuesday.

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Rosenberg, quoted at CNBC calls current economic conditions "a depression, and not just some garden-variety recession," and notes that any good news both during the initial 1929-33 recession and the one that began in 2008 triggered "euphoric response."

He further points out that the 1929-33 recession saw six quarterly bounces in GDP with an average gain of 8 percent, sending the stock market to a 50 percent rally in early 1930 as investors thought the worst had passed.