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Farrell: There Are No Surprises

I maybe should say there will be no surprises. Not from Angie and Frankie, not from Ben, and not from the President.

German Chancellor Angela Merkel and French President Nicolas Sarkozy.
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German Chancellor Angela Merkel and French President Nicolas Sarkozy.

After much ballyhoo (I have never used that word before. I'm not sure I like it. Sounds too upper crust British) the meeting between Merkel and Sarkozy produced nothing but disappointment. There will be, according to Chancellor Merkel, no Eurobonds. I don't blame her or the German voter who would ultimately be on the hook. But if there are no Eurobonds, then at least expand the European Financial Stability Facility (EFSF).

No way say the darling couple rivaled in attractiveness only by Kate and William. Who, by the way, were totally eclipsed by sister Pippa. Just ask anyone on the trading desk. We were all riveted to the royal wedding and Pippa was the uncontested star. I recused myself from the vote in that I am six times her age.

No expansion of the EFSF to step into the bond market to try and stabilize prices if it hits the fan again is going to lead to chaos. The original fund was 440 billion euros and half of that has been committed. The European Central Bank has overstepped its borders with bond purchases already. If Spain, and especially Italy, comes under attack the EFSF is woefully underfunded. But no one expected anything substantive to come out of the two leader summit and nothing did; except disappointment.

Chairman Bernanke will give his Jackson Hole speech this Friday and there is speculation/hope in the equity market he will announce some form of QE 3. Not a chance, and it's not because he has seen the Texas dawn and thinks it's treasonous. At best the Chairman will repeat what has been done, his outlook for the future and he might, might, list again the remaining tools he has left and the order in which he would deploy them. For example, he could say the Fed will stop paying interest on excess reserves, or he might consider lengthening the existing portfolio's average maturity to keep long rates low (but long rates are at record lows). This is called "operation twist" after a similar move many years ago.

There will be no new ground broken. There are no secret plans to be announced.

Similarly, when the President comes back from the Vineyard, he has said he will have a new plan for curing our ills. What could have possessed him ? He cannot have any new, serious ideas about reinvigorating the economy. There are none. And if he had business experience he would know that. He will probably call for, as he already has, an extension of the payroll tax cut and probably extend it to the business half of the tax. A further extension in unemployment benefits, more infrastructure, higher taxes on the evil money mavens at the top of the feeding chain. Monday's Financial Times of London editorialized that entitlement spending should be curbed by raising the retirement age. I'm all for that but is there a chance of getting anything through Congress? The Republicans want the economy to be in the worst shape possible come election to recapture the White House. I wonder if public opinion of our elected munchkins could actually go negative?

The President might well play his side of the Washington 'gotcha' game by proposing more spending on roads and such, along with a tax credit for companies that hire new workers. If the Republicans don't pass these measures it will be spun into evil deeds by those bad guys. And, no company hires workers for a short term tax break. They hire workers because they have a job need to fill. So corporate America will be listed as among the evildoers who just don't understand how smart this Administration is. Not that the line-up of possible opponents inspires much confidence.

But we know all of this. So back to the game of trying to figure what the stock market might be worth if we can't break out of the downward drift, or spiral if your feeling very blue. Trailing twelve month earnings per share are about $95, or so I read. Second quarter earnings annualized are even higher. The consensus for this year is still too high with the rapid mark-down in GDP estimates we have seen the last few weeks. But let's say next year could be $100 (this years consensus) if we avoid recession . A recession usually knocks earnings down about 20 percent. So next year could be $80. But, my pal Jason Trennert of Strategas wrote that there are very few credit or inventory excesses to be worked off, so it might not be that bad.

Or, it might not be at all.

Maybe we avoid a double dip.

But assume we don't and it looks like $80 is going to be the number. Uber-bears say that should be valued at 10 times. There have been instances of multiples that low. But I would prefer to look back to March, 2009. That's when the market bottomed at 666 (yes- sign of the devil) and the trailing PE was 12 times. 12 times $80 gives us a very depressing 960 target for the S&P(we are about 1130 now). BUT, interest rates are very low and low rates equal higher multiples. I am not a rose colored glasses guy, but I feel that 1120 will be a strong battle line and if it fails, 1020-ish will be the absolute bottom. 1120-1130 is a 1/3rd correction of the advance that began in March, 2009 and 1020-1030 is a 1/2 retracement. If we get to 1020-1030 and an $80 number is correct, I think the market at 12.5 times with the ten year yield at 2 percent would be a wonderful buying opportunity. I think the current level is a very good price opportunity, but I would like to see the 1120-1130 area tested a few times.

This memo will self destruct after you read it so there will be no written record of projections if I am incorrect. Proceed at your own risk. What the heck do I know?

Vincent Farrell, Jr. is chief investment officer at Ticonderoga Securities and a regular contributor to CNBC.

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