Earnings and PE Ratios Mean Equities Could Drop a Lot More

FN: The S&P 500 could drop down to as low as 315 if earning and PE ratios do what they did during the Great Depression.

"The moral of the story of course is that a PE ratio is pretty meaningless by itself. What matters is where earnings will be in the future. The best guide to that is simply mean reversion. Corporate profits tend to revert to about 6% of GDP. They recently peaked at almost twice that. If they bottom at half this average that would be a 75% fall just like in the Depression. If that happens we might expect the S&P to fall to at least a PE of 15. The S&P 500 earnings peaked about about 85 so a 75% decline would be 21 and a 15 PE would bring the index to a horrifying 315 a 65% decline from here."

Full post over at Certain Ruin, Earnings and PE Ratios in the Great Depression.

India: Maybe Not So Sustainable

FN: My last post on the subject of India was Sustainable? Or False Hope?. Yesterday the market voted False Hope after the government budget was released by dropping almost 6%. The budget deficit widened to 6.8% of GDP, from 6%, forcing the government to borrow record amounts.

Inquiring minds would like to know how this will all work. If every damn country in the world is running massive budget deficits, where is all the money going to come from and what is going to happen to interest rates?

Mukherjee Seeks Investors' Support for Indian Budget (Update1): " India’s Finance Minister Pranab Mukherjee will seek to convince investors that yesterday’s budget will help turn around the economy after stocks plunged the most in six months.

The finance minister is due to meet industry groups in New Delhi today after the stock index dropped 5.8 percent yesterday and the rupee suffered its worst fall in almost six weeks. Markets tumbled as Mukherjee unveiled the widest budget deficit in 16 years and failed to lay out firm plans to sell state-run assets and ease foreign investment rules.

Mukherjee, who presented his first budget in 1982 when India was a closed economy allied to the Soviet Union, yesterday pledged to spend more on food subsidies and rural jobs to help aid the poor. The 73-year-old politician now needs to convince investors that corporate India will also benefit from the rural growth, tax relief and increased outlays on roads and power.

The budget “will lead to faster economic growth, but it wasn’t packaged and sold well,” said Vikram Kotak, who helps manage the equivalent of $2.4 billion in Indian stocks and bonds at Birla Sun Life Insurance Co. in Mumbai. “His intentions in the budget were good. He now needs to convey them.”

Bank of America Loses More Money, Obama Will Regret Fake Stress Test

FN: The banks aren't done yet with the write downs and losses. Not by a long shot. Now that the unemployment rate is approaching double digits, with the heavily massaged NFP number at 9.4%, expect much more pain at the banks.

They really should have done an ACTUAL stress test. The fake one will come to haunt the Obama administration sooner rather than later. When the TARP money finally runs out AND bank failures actually accelerate, it will be difficult or even impossible to convince the American public to fund another massive bailout party. If a bank that received TARP money implodes and needs more, that will be bad enough. However, if a bank that received and then RETURNED TARP money implodes, things might finally hit the boiling point with Joe Sixpack. With nothing left to lose, the masses might actually make some noise and cause a ruckus. That is why a real stress test would have been so useful.

Reality always trumps fantasy. Eventually.

Bank of America’s Bad Loans Top $7 Billion, Credit Suisse Says: "Bank of America Corp., the largest U.S. lender, faces a 10 percent jump in uncollectible loans to $7.6 billion when it reports second-quarter earnings, Credit Suisse said in a report today.

Bad debts included $1.9 billion tied to home equity, and about 10.4 percent of credit card loans will be written off, analyst Moshe Orenbuch wrote in the report dated today. The bank, based in Charlotte, North Carolina, charged off $6.9 billion of loans in the first quarter, he said.

Bank of America, first in the nation by assets and deposits, will report a 32-cent a share profit for the quarter, including a $5.2 billion pretax gain from the sale of China Construction Bank Corp. shares, Orenbuch said. Excluding that gain and a $750 million assessment to bolster the Federal Deposit Insurance Corp.’s insurance fund, the bank probably lost 15 cents a share, Orenbuch wrote."

VIX Drops, Hides Option Bets Markets Will Fall

“Too many people are thinking the worst is over, life gets better from here. We’re scratching our heads, going, ‘Something doesn’t feel right here.’ It’s probably better to have some insurance on the books.” -Peter Sorrentino, Huntington

FN: Complacency has set it... and that is never good. I last mentioned complacency and volatility in Where's the Volume and the Volatility?

Biggest VIX Drop Hides Options Bets S&P 500 Will Fall (Update1): "The biggest drop in U.S. options prices since 1998 masks growing anxiety over the stock market’s rebound, as traders pay more for bearish contracts than any time since before the failure of Lehman Brothers Holdings Inc.

Investors are spending the most since August 2008 to protect against a 10 percent decline in the Standard & Poor’s 500 Index versus wagers on an advance, according to data compiled by Bloomberg. That’s one month prior to New York-based Lehman’s bankruptcy. The premium on so-called put contracts increased even after the Chicago Board Options Exchange Volatility Index, a gauge of U.S. options prices known as the VIX, fell 40 percent last quarter.

Traders are locking in gains on the S&P 500, which rose as much as 40 percent since March, on concern the worst U.S. recession in a half century isn’t abating, according to Huntington Asset Management, BlackRock Inc. and Fiduciary Trust Co. The widening gap between bullish and bearish options belies the VIX’s retreat to below its level when Lehman collapsed and comes as U.S. companies prepare to report second-quarter earnings this week.

“Too many people are thinking the worst is over, life gets better from here,” said Peter Sorrentino, who helps manage $13.8 billion at Huntington Asset in Cincinnati. “We’re scratching our heads, going, ‘Something doesn’t feel right here.’ It’s probably better to have some insurance on the books.”

Oil Breaking Down

Pre-market oil gapped down as much as $3.00 and is now trading below $64.00. That would put the price below the 50 and 200 day EMAs (red and green lines) and the trendline off the Feb 18th low.

The economic data from last week, with non-farm having the most impact, wiped out the "Green Shoots" theory.

Commodities and the whole "reflation trade" are especially reliant on "Green Shoots".

Now commodities are breaking down everywhere.