Stock Market -- Fundamentals

The SP 500 Market Tracker has dropped further in Sept. and is
now at 1025 fair value based on 12 month earnings and inflation
readings. The earnings index has fallen from an annual rate of
around 90.0 in mid-2007 to 69.0 presently. The vast bulk of
the carnage has been in the financial sector, but as production
growth slows globally, more sectors have been implicated. The
p/e ratio for the Tracker has contracted as well over this period
as inflation accelerated sharply until just recently (Rising
inflation raises the investment hurdle rate and suppresses the
market multiple).

The SP 500 is trading at around 1200 at posting time. I think
the market is discounting a return to 80.0 earning power for the
"500" and is probably shading the p/e ratio more for future net
per share risk than for inflation. The 80 number has been the
assumption through much of 2008 as investors figured there
would be an end to the bleeding in the financial sector this year
and some bounceback in non-finacial earnings. The direction of
the economy is a challenge to those assumptions, so the 17%
premium in price of the "500" over the Tracker probably
should not be taken lightly.

My forward looking indicators continue to improve, but the
positive trend of monetary liquidity still suggests a sustainable
improvement in economic activity and profits could be a good
9 months out in time.

One important set of indicators -- credit quality spreads -- are
moving the wrong way reflecting a sharp rise in the price of
risk across the board. Not only is confidence in the global
financial system and economy low now, the US credit markets
are in lockdown mode, with all eyes on the Paulson bailout
plan. This is a bad plan on constitutional, economic and
financial grounds, but the hope appears to be that enactment
in modified form will be materially better than inaction. At
any rate, a positive turn in credit quality spreads would
strengthen the case for equities considerably.