Stock Market In Perspective

Early last autumn, when I turned more cautious on the market, it
was on an astoundingly strong trajectory. Even after the Jan. ' 10
break, it was still on a trajectory that would have taken the SP 500
to new record highs by year's end. Not impossible, but not a good
bet, either. So, yes, the rise in the market was too steep, but it was
partly understandable given the extraordinary rebound of corporate
profits.

My SP 500 Market Tracker currently projects the index to rise 25%
from current levels to 1350 by year-end 2010 as 12 month net per
share surges higher. From a technical perspective, this would put the
market on a trajectory that is still extremely strong by price chart
standards, but the Tracker is merely assigning a moderate 16.5 p/e
to earning power in excess of $80 per share.

Now, here is where it gets more tricky. S&P profits have exceeded
those suggested by the sharp run ups in my leading indicator sets
reflecting the deep cost cutting companies have undertaken. Since
the bulk of the cost cutting is past, profit growth was bound to
moderate. Moreover, when measured on yr/yr % change, the
weekly economic leading indicators have hit and have just crossed
an inflection point, signaling that a slowing of profits growth is out
ahead. A significant slowdown in profits momentum is factored into
the $80+ per share projection for the "500". But, there is a problem.
Once the leading indicators break the initial recovery signal surge,
further upside momentum of the indicators is not only far more
mild, it is more difficult to project with confidence. On top of that,
the "fit" between the indicators and the profit trend loosens past
the inflection point of the indicators, although it must be said that
profits often do better than expected anyway.

The long and short of it is that with a sharp moderation in the trend
of the leading indicators underway, the stock market could not hold
a nearly impossibly strong price trend and has corrected since a clear
signal has been sent that profits growth is going to slow. This is
the fundamental event I warned about last autumn, an event that
came later than expected.

I am on the hook for expecting a solid year of economic and profits
recovery in 2010 and for expecting a continuation of the cyclical bull
market. Since earnings currently remain in a sharp upswing, I
think the market has overshot to the downside by 10%, although
conceding that a reaction of real consequence was required given
the extraordinary trajectory of the market from 3/09 - 4/10.

I expect a sharp recovery rally to get underway over the next 5-7
trading days. But I do see a period of uncertainty ahead for a couple
of months until we see how well the leading economic indicators
progress.