Kass: Bearish Arguments Are Roaring

It is the mark of an instructed mind to rest satisfied with the degree of precision to which the nature of the subject admits and not to seek exactness when only an approximation of the truth is possible.
-- Aristotle

This morning's opening missive will address top-down market valuation, explain why I believe the price-to-earnings multiple expansion beginning six months ago appears to be coming to an end and then go on to recap the forces that make me more bearish on corporate profits vis-a-vis the emerging and more bullish consensus.

Given that the First Call total of S&P operating earnings for the first half of this year was about $30.50 a share and is estimated at $15 a share for the third quarter ending Sept. 30, 2009, it is safe to say that 2009 S&P operating profits will approximate $62 a share. First Call consensus S&P earnings forecasts for 2010 now run around $72 to $74 a share, for a gain of almost 18% year over year.

Many strategists (both bullish and bearish) assume that a fair value P/E multiple -- based on interest rates and inflation -- rests at about 15.5 times. Averaging the 2009 and 2010 S&P consensus forecasts produces a melded $67.50 S&P EPS, a year-end target of 1045 and a mid-2010 S&P target of 1130 on an EPS of $73 a share -- against the current S&P level of 1043.

Bearish strategists such as David Rosenberg (this weekend's Barron's interview) believe the current S&P level is discounting a 40% increase in 2010 earnings over 2009, but the consensus believes (above) that about 10% growth is being discounted.

Bearish strategists (again) like Rosie expect real GDP growth of about 1% to 2% next year, but the consensus now anticipates 3% to 3.5% growth in 2010.