Bull: S&P Setting Up For 17% Rally

October 09, 2008

Charting actual price movements indicates the index is positioned to rally to at least 1,150. 

Earnings forecasts are fine as part of a broad fundamental analysis of markets. But basing projections on what analysts expect companies to earn—as well as applying historical price-earnings ratios to charts—is a dubious practice at best.

That's why we're not buying The Active Indexer's forecasts that the next move by the S&P 500 will be down to the 800 level or lower. (See related story here.)

Jerry SlusiewiczLet's face it, P/E ratios are extremely fickle. When projecting forward P/Es, you're basically trying to guess the market's appetite for risk for each dollar earned by S&P 500 stocks. That's a very high-stakes projections game to play.

In these times, it's even harder to come up with accurate calls on P/E movements through the use of charting techniques. You've got to consider not only changes in guidance by companies themselves, but also analysts' track records in revising their original earnings estimates.

In the next several quarters, it's highly likely that earnings estimates will move all over the board. Trying to pinpoint where P/Es will wind up in the future is pure folly.

Rather, let's look at charts of the S&P 500's price history to extrapolate a more reasonable expectation of future market swings.

From the opening day of trading in October through Wednesday's close, the S&P 500 was down 15.7%. That's six trading days. Consider also that from Aug. 15, the S&P 500 was down 24.5%, not counting dividends.

Share prices of the 500 biggest companies in the U.S. didn't plummet in such a short period because of a sudden change in fundamentals and earnings. Investors didn't wake up one morning and decide the U.S. stock market was nearly 25% overpriced.

This correction is pure panic in its most classic form. Clearly, what we've been seeing lately is a case of overkill. Professionals and amateurs alike who haven't been managing their portfolio risks well are going on a selling rampage. How bad is it? Counting Wednesday's performance, we've never seen a worse eight days of trading going back to World War II.  

From a purely objective standpoint, it just makes sense to figure we're approaching a bottom. It's too early to tell if this will turn out to be one that lasts awhile. But it definitely looks like a trading point with a projected price rise to 1,150-1,200 on the S&P 500 before year's end.

That translates to a 17% to 22% rise from here by the close of 2008.

Before anyone thinks I'm too crazy, let's put this into perspective. Even if we do get to those levels, we're simply talking about rising back to where we were two weeks ago. And that's to the day through Wednesday.

If you look at the S&P 500's peak on Oct. 11, 2007, the downtrend seems to have upside resistance at around 1,320. That's based on a confluence of technical factors, including the index's historical 200-day moving price average. In fact, looking at near-term resistance, the average closing price in the past 50 days on the S&P 500 was 1,230 heading into Thursday.

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