Farrell: Market In A Bottoming Process

There seems more to cover than is possible. In "The Call" today we gave a mighty effort to touch all bases, however. The big deal is the Fed's move to buy commercial paper. This was a necessary move as the total CP outstanding had fallen by over $200 billion in the last three weeks.

The market was freezing and needed to be defrosted. Additionally, the government is allowing US based multinationals to borrow without tax consequences some of the several hundred billion they hold offshore. This money represents profits on foreign sales held externally to avoid paying the US tax. An "in-house" CP facility is essentially being set up and that will take some of the strain off the general market.

There was some discussion was on whether this is a bottom or not. Trying to call that is a non-starter, but I tried to look at valuation with Trish and Melissa. The earnings season starts after the close today with Alcoa's announcement. The consensus of strategists for earnings for the S&P for next year is $96. I think that is way too high. Taking a drastic cut in line with earnings declines from prior periods of economic stress in mind you can come up with $77. That is about as low an estimate as I have seen. If earnings were to fall that much (it would be a 17% decline from the annualized peak of $91.50 hit in Q2 2007) I would guess that inflation would not be a problem.

  • Pros and Cons of Rate Cut
  • Fed, Treasury, FDIC Take New Steps to Defrost Credit
  • Fed, Treasury Mulling Commercial Paper Support

The "Rule of Twenty", which is not a rule but an observation, holds that the market multiple and the inflation rate add up to 20. If inflation were to head to say 3 or 4% then a multiple of 15-16 would be justified. Let's slash that as well and use 13 times. That would give us a downside of about 1,000 on the S&P against its current price of 1029. I do not mean 1,000 as a target, but rather as a directional signal. It seems to me the market is in a bottoming process.

When terror strikes, all the analysis in the world goes out the window. But if we believe that Bernanke's study of the Great Depression offers him insight as to what to do now against what wasn't done then, it is possible we will get through this and valuation tools will be helpful.

  • Bernanke: Rate Cut Possible to Cure 'Historic' Slump