Unexpectedly Intriguing!
22 June 2009

Nouriel Roubini, aka "Dr. Doom," has weighed in on the state of the stock market at this point in June 2009. He identifies three reasons why we're all doomed stocks will plunge, well, really soon! (HT: Yahoo! Finance tech|ticker):

He points to three factors that will lead to a correction in the near future:

1. Volatility and Uncertainty Will Increase. Note: the CBOE Volatility Index is currently down more than 50% since the October panic.

2. Corporate Earnings Will Disappoint. He says the market is pricing in a robust ‘V’ shape recovery. However, when earnings miss expectations, buyers will turn into sellers, as was the case this week with FedEx. (Research In Motion shares were down early Friday after the firm’s guidance failed to live up to expectations.)

3. The Global Financial System Still Faces Serious Problems. Roubini thinks unemployment will rise to 11%, bank losses will increase across the globe, and the recession in Europe will get worse.

To which, our response to each reason given by today's leading prophet of Doom(TM) is:

  1. Huh?
  2. Really?, and
  3. Duh.

Let's take each one of these in greater detail....

We're confused by Roubini's reasoning for Item 1, because his logic would seem to all boil down to: "volatility will go up because it has gone down" and because of "investor uncertainty," even though investors may be getting back into riskier investments because volatility is down. To be fair, Roubini only briefly touches on the topic, but without some leading indicator to anticipate market volatility, this view is little other than a coin-toss prediction.

On the second point, there's little doubt that corporate earnings will disappoint, certainly compared to a year ago, but where is there any evidence that the market is pricing in a "V-shaped recovery?"

S&P 500 Expected Trailing Year Dividends Per Share (Historic and Futures Data) As Of 22 June 2009 Since last December, we've demonstrated that changes in what investor's expect to be the future rate of growth of the market's dividends per share has been *the* primary driving factor behind the changes we've seen in stock prices. We thought it would be instructive to consider how those dividends per share have changed since the stock market bottomed on 9 March 2009.

The chart of how trailing year dividends per share for the S&P 500, determined by combining historic and expected future dividend data over time, reveals that the market is very much *not* expecting a V-shaped recovery anytime soon. We see that in the narrow spread between the lowest expected trailing year dividend per share value for the S&P 500 currently projected for the second quarter of 2010 and the fourth quarter of 2010, the farthest ahead we can look using the dividend futures data.

We realize that it takes some advanced chart reading skills to see this pattern in the graph, so to make it easier, the two bar charts below show the value of the trailing year dividends per share forecast for the S&P 500 as of 12 March 2009 and as of 22 June 2009, for each quarter from 2009Q1 through 2010Q4. We selected 12 March 2009 because this is the first date for which we have dividend futures data for the fourth quarter of 2010 and because it's very close to the levels of 9 March 2009.

S&P 500 Expected Trailing Year Dividends per Share, 12 March 2009 S&P 500 Expected Trailing Year Dividends per Share, 22 June 2009

The horizontal line on both charts indicates the general range that the S&P 500's trailing year dividends per share are currently expected to fall in the period spanning the end of 2009 through the end of 2010. If you want to call this a "V-shaped" recovery, it's a contender for being the flattest V-shaped recovery on record.

In reality, stock prices have risen since hitting bottom on 9 March 2009 almost solely because investors expect dividends per share to stop falling - not because of projections of robust economic growth. That's what's provided the positive acceleration to drive stock prices upward.

We'll leave Roubini's third observation alone - mainly because these are pretty reasonable projections based on current economic conditions - unlike Roubini's reading of the future for stock prices.

Finally, we don't disagree that stock prices will fall from their recent highs (right about now, as a matter of fact!) We simply do so for different reasons - and primarily because of the data we have.

Update 22 June 2009 4:42 PM EDT: We've reinvested our entire retirement portfolio back in the S&P 500 today. Our reasoning for the timing of our move is similar to that behind our decision to sell our entire S&P 500 stake back on 11 June 2009.

And for what it's worth, we don't have any special knowledge that the stock market is finished heading downward. Our retirement investing strategy is built around the idea of getting to where we want to be sooner, with less risk. It's not about perfectly timing all the highs and lows in the market and it's certainly not a recipe to get rich quick!

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