Stock Market Bulls Seeing Continuing Rally Should Be Seeing Red

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Alcoa kicked off earnings season last night, a time when corporate America presents its report card for the previous quarter and updates stock investors as to where earnings and hence stock prices might be heading in the future. Investors forecast stock prices from an analysis of company earnings and price-to-earnings multiples according to a simple formula: stock price equals earnings times multiple. Market bulls and bears always vigorously debate earnings and multiples and usually each side manages to draw from historical data and metrics to support their bullish and bearish outlooks.

However, in these unstable times, the major disparity in outlooks has less to do with assessments of foreseeable earnings and more to do with the down-the-road context for those earnings, which will be reflected in stock multiples; bulls seem to have a pre-crisis business-as-usual mindset and assume the financial crisis and its effects are either behind us, or far enough ahead in the future (and being kept at bay by global monetary easing) as to be irrelevant to near-term stock price forecasts. As a result, bulls’ forecasts readily use historical metrics and stock multiples; bears are less sanguine and fearful that fragile global economies and markets could crash once again and take investors appetite for risk with them, an outcome that could meaningfully reduce stock multiples for years to come.

The bulls claim this is just another in a long line of garden-variety financial crises that have wreaked havoc with the financial markets. Bears claim this crisis-recovery cycle is potentially more problematic and protracted than others, and point to many unprecedented events that are historically unique and took decades to culminate. First, the liquidity that has been pumped to restore health to global economies and markets is unprecedented in scale and scope, and while (temporarily) propping up financial markets, has largely failed to spur economic growth. Even optimists have to be worried that this heroic effort has largely failed thus far, and must wonder what can be done next if markets take a turn for the worse. Second, along the way, the credit-worthiness of the US Government, the fulcrum for financial markets for more than 60 years, was downgraded, and even the sanctity of FDIC insurance for US bank deposits has been called into question after the bank debacle in Cyprus. Third, global economic growth over the past several decades has been on the back of America’s willingness to borrow and consume beyond its means, a phenomena made possible by the US dollar’s dominance as a global reserve currency. Now the US dollar’s reserve currency status is in jeopardy, America’s ability to borrow has been severely limited by its enormous debt and interest rates are at historic lows, and can only rise in the future. Fourth, as bad off as America is right now, other major economies, including the Euro zone, Japan and China, are economically worse off, so as usual America will need to take the lead in solving this problem. Fifth, there is mounting evidence that the tepid global economic recovery is once again beginning to flat-line and falter as the list of global economic and financial woes seems to grow each day.

In view of the foregoing, adopting a business-as-usual approach in forecasting the future trajectory of stock prices seems naïve and near-sighted to say the least.

Source by Joe DelCasino

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