A Rally or Turnaround

I am not a market technician or rally but charts and short-termism has become a necessary ingredient to establishing short positions - fundamentals ultimately rule but technical and irrational movements in stocks can make life very unpleasant. The radical movements we saw last week have been mirrored once -- from 1929-1932. That should tell you something.

That being said, I look at fundamentals and all I see is a market moving down, over time. This view is based on a belief the market regressed then overshoots the mean -- and that mean is driven by the multiple of profits assigned to the market by investors. Fortunately, that is at the center of the current debate on the long term valuation of the market. What will corporate profits be in 2009 and 2010 and what multiple will the market assign to those earnings. Investors and traders, especially those playing the short side, need consider the following:

- The debate is underway about profits and the range of opinion is startling, from $25 a share on the S+P 500 to $55. To be conservative, let's just split the difference - let's make it $40.

- The potential multiple of profits, depending on your view of history -- are we closer to a recession than a Depression - and your view of profits in 2010 - is 9-12. Some people I would like to call some harsh names but will not and instead I will call them willfully misleading bulls that are long only see the top multiple at 15. If we include them in the discussion, the median is 12.

- Where I grew up, 12 times $40 is 480 -- that is 480 on the S+P 500 - or a 37% decline from right here, right now.

Extreme? Consider the fundamentals:

- The next mortgage meltdown is beginning and will last up to three years and end up larger than the last one, this one built around option ARMs, ALT-A mortgages and prime mortgages improperly rated or with folks either unemployed or so upside down on their homes they just walk away. Either look for Ivy Zelman's comments somewhere on the Web or watch an outstanding piece on CBS News' Sixty Minutes http://www.youtube.com/watch?v=XR0asxyRGX4.

- The current and future mortgage meltdown will be joined by a commercial real estate and private equity meltdown and that in turn makes current bank "marks" and other measures of capital adequacy problematic. I disagree with Dr. Bernanke -- the big banks are or will be insolvent. Even if they fudge the "stress tests" -- and fudge "mark to market" -- and it looks like they are going to do both in tandem - assets will decline in real world value. And, private investors will do their own valuations of bank equity and bonds. Do you think they are not going to ignore Citigroup's (C) $1.2 trillion dollars in off-balance sheet assets? My belief, using simple math, is the banking and credit crisis will not be fixed until the banks are re-capitalized.In the US alone that could take up to $2 trillion dollars.

- The US consumer has pulled back do to necessity -- and will continue to do so as credit is pulled back, credit standards are tightened, people refuse to borrow. This is driven by the recession and the incredible decline in wealth -- 18% of the nation's accumulated wealth evaporated last year. This in turn is already leading to a permanent reduction in consumer spending. This in turn will lead to business failures here and the failure of entire economies overseas. Read an interview with Stephanie Pomboy in Barrons (mid December of 2008) to get a great view of this contraction.

The bottom line: the economy is going to be in full retreat throughout 2009, will not bottom until mid to late 2010 and corporate profits and the market will catch up with this reality. You cannot ignore rallies but view this as just that -- a bear market rally.