Stock Market -- Fundamentals Profile

Observations

1. The market remains in earnings recovery anticipation mode. SP
500 eps for the past 12 months (7/31/09) stand at $39.70. Investors
are presently pricing in a return to $60. earning power, which
primarily reflects heavy cost cutting and slight growth just ahead.
(Q 2 '09 eps should come in around $14.)

2. On a very long term trend basis, SP 500 net per share for 2009
works out to $75. Using the same model, top-of-the-channel eps
would equal about $85. With 12 month earns running about 47%
below the "normal" $75., you get a good sense of how deep the
recession has been.

3. Investors have not changed the broader valuation framework for
the market during this steep downturn. Specifically, players are
pricing in a return to moderate inflation of 3.0 - 3.5% with economic
recovery and have ignored the mild 12 month deflation readings
witnessed recently. This is important. Should economic recovery not
occur and should deflation pressures continue, the market would be
vulnerable to a downward adjustment of earnings and fears that a
period of more prolonged deflation could signal a lengthy period of
sub-par economic performance. This kind of serious further downside
would not be a foregone conclusion, but it would be a reasonable one.

4. Looking out over the next year, the speed of global economic
recovery should be the dominant feature for the stock market. With
a lower cost structure evident, and with the SP 500 companies now
holding prodigious cash, there exists sizable positive earnings leverage
from economic recovery, even if it is mild in scope. With recovery,
profit margins will expand and earnings will benefit from cash mergers
and acquisitions.

5. Despite the rapid run-up in stocks since 3/09, the SP 500 price level
does not include a presumption of a sizable positive take-off in earns.
In my framework, players are looking at $60 earning power now, with
the potential to scale that number up if recovery does indeed take hold.
My thinking is that in a moderate economic recovery, expectations
for SP 500 earning power of $75. - 80. will take hold sooner rather
than later, and that the market would chart a course for 1250 - 1325.

6. The problems the banks and investment banks have experienced
coupled with exceptional weakness in sales over the past year or so
have left a residue of investor fear and no willingness yet to take the
concept of a decent global economic recovery for granted. We have
now entered a period where there is substantial downside price
risk to a failed recovery as well as continuing large upside price
potential should recovery proceed smoothly. This means that eyes
will be fixed on progress, and not just benefits from cost cutting, but
from a resumption of top line growth as well. Given this risk / reward
profile, there is good potential for elevated volatility over the next 6
odd months as investors monitor news carefully for indications of
progress.

7. The SP 500 dividend stands at $21.50. With recovery, the dividend
will likely increase to about $30. by Half '1 2011.

For more detail on SP 500 earnings, go here.