Why There's No Market Rally

If you want insight into why the stock market is having trouble advancing, just look at what it is going on with estimates of 2009 earnings. There is a vast army of financial nerds who look over financial statements, and crunch numbers for their companies. There are two classes of numbers crunchers:

1) individual company analysts (known as "bottom-up" analysts); and

2) economists who make broad estimates for earnings by sector based on macroeconomic data (known as "top-down" analysts).

Right now, according to Standard and Poor's, here are the consensus estimates for earnings for 2009 for the S&P 500 from the two camps:

Bottom-up: $91.85

Top-down: $62.98

Are we talking about the same country here? The differences are huge: the bottom-up estimates are 50 PERCENT HIGHER than the top-down estimates! Why is there so much of a difference between the two camps? I'll tell you why in a minute. First, let me give you some advice: go with the top-down people.

Normally, the stock market bottoms out at about 10 times forward earnings. So if we take the estimates of the bottom-up people, the S&P next year will be about 918 ($91.85 x 10).

Right now, the S&P is about 850, so by the estimates of the bottom-up people the S&P is currently trading at 9.2 times forward earnings (850/$91.85). If the bottom-up people are right, THE STOCK MARKET RIGHT NOW IS CHEAP. Buy now!

Now, look at the top-down number: $62.98. This puts the S&P 500 at about 630 next year at the bottom ($62.98 x 10 = 630).

Yikes! Remember, we are at 850 right now. Based on this estimate, the S&P right now is trading at 13.5 times forward earnings (850/$62.98). That is NOT CHEAP by historic standards (the historic average P/E multiple is 15 times forward earnings, but we are not talking averages here. We are talking cheap).

The point is this: if you believe the top-down strategists, the stock market right now is NOT CHEAP. Don't buy. This matters, because the most bearish strategists have been the most correct ones this year. Therefore, these bearish strategists have the most clout. For now, traders believe them more than the more bullish analysts. That's why the stock market is having trouble rallying.

Now, let me tell you why there is such a difference between the top-down and bottom-up camps:

1) The top-down people are strategists with a much larger world view than analysts (bottom-up); they are quicker to cut numbers, particularly in times of stress.

2) bottom-up analysts are myopic, watching only their company's and sectors, and often slow to react to changes in the economy;

3) many bottom-up analysts do little more than follow their company's guidance, so when company's are slow to cut numbers, so are the analysts;

4) the quality of sell-side bottom-up analysts has declined in recent years as brokerage firms have cut their coverage of many companies.

Get the point? Guess who I follow?

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