Bull market dreams

Are dreams of ignorant bliss if one is referring to general U.S. stock indices like the S&P 500. Standard and Poors, who are not exactly the most bearish of market cheerleaders, estimates the 2nd quarter 2009 earnings for the S&P 500 using the GAAP (generally accepted accounting principles) method will be $15.90. Now, GAAP is the historical standard by which the price to earnings (i.e. PE) ratio is calculated.

In the last two decades of bullish excess, pundits and supposed experts in market analysis refer to operating earnings, much like banks use "mark to fantasy" accounting. Both of these views of the value of financial things are, of course, off base and what got us into trouble in the first place. GAAP earnings are what's important and it is common wisdom that secular (i.e. 1-2 decades long) bear markets end when the PE ratio has reached 10 or less. By the way, in case you're still in denial, we are in the midst of a secular bear market that started in 2000.

Anyhoo, think about a PE ratio of 10 for earnings of $16. By my calculations, that would mean the S&P 500 is going to reach 160 before this bear market is over, or a drop of 80% from today's close of 826. This assumes that earnings will not drop further after the 2nd quarter of 2009, which is NOT a safe assumption. For those who insist on using the more bullish operating earnings to calculate the PE ratio, guess what? Standard and Poors estimated operating earnings estimate for Q2 2009 is $52.42, so maybe the wildly optimistic bulls are right and S&P 500 will only drop to 524 by the end of this secular bear market (a 36.5% haircut from today's close)...

Will we really get that low? I don't know, but to think it can't happen is delusional and overly complacent in my opinion. It also would ignore 100 years of historical data and make the tenuous assumption that this time really is different (why, because we have Obama, Bernanke and Geithner running the show?!).

By the way, if the Dow Jones Industrial Average dropped 80% from today's close of 7850 to reach a secular bear market bottom (using the more conservative, traditional approach to calculating PE ratios rather than the "mark to fantasy" operating earnings mantra of the young paid shills from Wall street), that would mean gold would only have to rise to $1570/ounce to create a 1:1 Dow:Gold ratio.