Monday, October 6, 2008

Dow Down 370


Everyone’s talking about the world-wide financial crisis, and that may have been the main driver behind today’s 370-point-loss on the Dow. But don’t forget the effect of the recession that’s unfolding.

It will do two things: Erode earnings and reduce the P/E. Both of these developments will further depress the stock market.

Corporate earnings have done very well since the 2000 – 2002 bust. Now, with the recession, they’re headed for the basement. That alone would be bad for the stock market.

In addition, earnings’ strong performance since the bust kept the P/E (price/earnings) ratio above its historical average. Strong earnings inspired investors to maintain a high price for stocks relative to earnings. But falling earnings will erode confidence, further depressing stocks.

Tomorrow’s posting will mobilize a set of charts to illustrate these points.

© 2008 Michael B. Lehmann

No comments: