Tuesday, November 11, 2008

Equity Bottom Revisited

A few posts back (10/10/08), I made note of the 8,000 level on the Dow Jones Industrial Average as a key support level. The index hit an intraday low of 7,773.71 on that day and hit an intraday low of 8,085.37 on 10/27/08. Let's see if the fundamentals tie out with this technical support level.

For this exercise I will use the S&P 500 as the equity market proxy because data is more readily available.

- Quarterly earnings peaked in the 2nd quarter of 2007 at $84.95

- S&P is forecasting earnings of $48.52 for the 4th quarter of 2009

- I think that forecast is a bit aggressive. Based on past peak to trough earnings swings, I am estimating earnings for the last quarter of 2009 will be $39.93

- The average earnings yield for the S&P 500 for the last 20 years is 4.886%

- $39.93 / 4.886% = 817.23

A bottom of 817.23 in the S&P 500 would roughly tie out to a level of 7,903.60 in the Dow, which is obviously pretty close to the technical support level. These levels would correspond to a drop of 9.09% from Tuesday's close and a drop of roughly 46% from the all-time highs set back in October, 2007.

I still believe that one must assign some probability to a scenario that drives corporate earnings even lower than my estimates. Therefore, I would not suggest a 100% portfolio exposure to equities, even at the support level. In the coming weeks, I would expect another test of the support level.

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