The Stock Market Could Plunge 50%, According to These Analysts

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The number 666 has spooky connotations for fans of horror films. It's also an ominous number that analysts at France-based Societe Generale (SoGen) want you to think about. That's their target price for the S&P 500. 

The S&P 500's 120 point drop since late March to a recent 1,305 has been painful enough, but does it really have another 50% to fall from here? Frankly, I think these analysts are being overly bearish , and I'll explain why in a few moments, but it's still worth hearing why they are so frightfully bearish.

Thebond signal
These folks say the bond market is telling equity investors something right now. Germany's 30-year bonds now yield less than 2%, which is precisely what happened in Japan in the late 1990s before the Japanese economy hit a wall. And for SoGen, that's a harbinger of more pain to come: "We still see [U.S.] 10[year] yields -- even now making new all-time lows -- falling below 1% as hard landings occur in China and the U.S."

These analysts say a looming sell-off, if it happens, would merely be the third phase of a three-stage bear market in stocks that began back in 2000. There is a logic in play behind thatcall . Remember that stocks made a solid upward move from 1982 to 2000, in what many now call a secular bull market . Some now say that the recent rebound from the lows of early 2009 was just a head fake in a broader secular bear market. 

And just as the final melt-up in stocks in 2000 created a dramatic end to the secular bull market, SoGen's analysts say the secular bear market will likely end in a similar fashion. They say the events in Greece are just the tip of the iceberg. "The eurozone crisis will be a sideshow when the main act appears on stage. As well as a slide back into recession in the United States, a hard landing in China will crush any residual optimism of the equity bulls, taking global equities below April 2009 lows."

These analysts spell out their case in emotionally-charged terms, predicting that "investors will lose all hope, most particularly in their belief that policymakers have any idea what they are doing." This kind of mood brings to mind a market era that initially shaped my exposure to stocks. The 1970s were also a time of hopelessness and despair, when inflation surged and looked to hamper the economy for many years to come. Many blue chip stocks looked awfully inexpensive early in the decade, trading at six or seven times trailing profits, but the grinding bear market pushed those multiples below five later in the decade. 

Why they're wrong
Even as it's helpful to look back at past market action for insights, these analysts appear to get it wrong on some very profound points. For starters, a comparison to the 1970s is simply unfair. Back then, inflation was nearly ruinous and fed a vicious cycle of underinvestment and weak profits. From auto makers to steel makers to retailers, corporate America had seemingly lost its way. Fast-forward to the current era, and Corporate America has never been more competitive. The country's pace of innovation remains robust, and in coming years as the global economy gets back on its feet, U.S. companies will likely be well-positioned in a number of growing global markets.

To suggest that we're headed even lower than the lows we saw in 2008 is also off-base. Back then, a number of companies carried too much debt along with bloated workforces. As I recently noted, share prices plunged for companies such as Ford ( F ) , Hertz ( HTZ ) , and Domino's Pizza ( DPZ ) as bankruptcy fears loomed. But corporate balance sheets have grown remarkably stronger in the past few years. Major cost cuts fueled solid cash flow , so once-troubled companies like Ford, for instance, now carry more cash than debt for the first time in decades. 

Moreover, many of these companies have taken great advantage of the record low interest rates to shift into low-cost debt. Their growing cash piles and lightened interest expense allows them to make important investments in their products, even as global rivals struggle while dealing with their more challenged domestic markets.

Lastly, to suggest that the bond market is signaling trouble for stocks, as the SoGen analysts do, also appears off the mark. Bonds are rallying (and bond yields are falling) precisely because there is a lot of excess liquidity in global markets that needs to be parked somewhere. Bonds are the default asset right now because of uncertainty out of Europe and China, but represent little further upside from here and potentially huge downside when the global economy regains its footing.

Frankly, it's hard to understand why these analysts are saying the S&P 500 will likely fall to 666. At that price, the market would trade for about six times projected 2012 profits -- assuming these profits come to pass. This kind of multiple has happened before, but only when inflation was much, much higher.

Can the stock market fall further in coming weeks and months? Surely, but global investors are fully aware that U.S. companies, many of which are already inexpensively-priced, represent some of the most appealing assets in the world right now.

Risks to Consider: My biggest concern involves Washington's decision to address 2013 budget and taxation questions AFTER the Presidential election. That's a short window of time and could easily scare investors later this summer as the issue starts to dominate the financial media headlines.

Action to Take --> You should prepare for further market weakness, but not by selling all your stocks. Instead, it's wise to hedge your portfolio exposure with bearish ETFs (exchange-traded funds) such as the ProShares Ultra Short S&P 500 ETF ( SDS ) or the Direxion Daily Small Cap Bear 3XShares ( TZA ) , which I own in my $100,000 Real-Money Portfolio .  Indeed, this is a great time to pounce on bargains that this market uncovers, especially stocks that have clear value support from their balance sheets and cash flow statements. Pair them with the right bearish hedges, and there's no reason to avoid stocks altogether.

[ Note: Be sure not to miss a single thing and have $100,000 Portfolio updates sent to your email inbox, free for a limited time, as soon as they're published by signing up here .]


-- David Sterman

David Sterman does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC owns shares of TZA, F in one or more if its "real money" portfolios.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

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This article appears in: Investing , Basics

Referenced Stocks: DPZ , F , HTZ , SDS , TZA

David Sterman

David Sterman

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