Thursday, January 8, 2009

Why yesterday was significant.

This is a little too short-term for my taste, but it does have implications for the next six months, so I want to post it anyway.

The stock market finally fell yesterday, and fell by 3%. This is very significant to us and bodes well for our short positions (though is very bad news for the market). Here's why:

I wrote in my last post that earnings season begins this Monday. Earnings season is always kicked off by Alcoa a week before everyone else starts reporting. It was Alcoa who - after market close two days ago - warned it was going to report terrible results, fire 13,000+ people, have earnings below already low estimates, and people realized S&P may downgrade their credit. Then Intel came out with its problems. Yesterday's 3% fall is significant, because it tells us that this market is not at all pricing in these "surprises". The news will continue to be just like this starting this Monday and continuing for the 4-6 weeks, as about 99% of S&P 500 companies will report the first quarterly reports, which will capture the meaningful impacts of what happened in September, October, and November in full detail, along with very bad year-over-year comparisons of Christmas. The market will learn that margins have been entirely destroyed in retail and that sales numbers have nothing to do with earnings numbers.

For the next two months there will be surprises and misses and downgrades, and all of it will surprise the market and panic people. Barack Obama will be making a big economic announcement today (or possibly next Thursday, I can't remember), probably saying he's going to try to get a big and meaningful plan through Congress as quickly as possible so it will be ready on day 1. He'll then be inaugurated on January 20th. What these two events do to the market I have no idea, and I don't care. I'm not a short-term trader. What is more important to me is that over the next six weeks earnings results will be terrible, and markets will probably fall on these poor fundamentals.

I should mention something else very important for us to understand. Up until now, I have only been talking about poor operating results. And when I predict S&P 500 earnings per share of $50, those are operating earnings. I haven't even mentioned the enormous write-downs that will come in on top of earnings and cause massive losses. Everything from heavily underfunded pension liabilities which now have to see payments increased, to credit default swap markdowns, to whatever. The writedowns will be enormous, and it appears by yesterday's markets around the world that no one is pricing in writedowns either. With writedowns, you could see S&P 500 earnings of perhaps $42 per share. This means that analyst estimates of earnings for 2009 are A FULL 100% HIGHER THAN THE WILL ACTUALLY BE.

I've had to endure a painful 25% rally since Thanksgiving which I believe had absoultely nothing to do with fundmentals and everything to do with misplaced hope in the incoming administration to save people from their mistakes. This next several weeks will likely be the largest earnings season analyst screw up in the history of the stock market. I can't imagine stocks staying high in those conditions.

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