Before you decide where stocks are headed in 2003, complete this little Christmas quiz. Pick the odd one out: a) an unbalanced economy, b) weak companies, c) misleading earnings statements, d) above-average valuations, e) geopolitical instability and f) Dow 11,000. Unlike many Detox readers, Wall Street's top stock touts are struggling to see anything anomalous in the above list. Just like last year, they're predicting big gains for stock indexes amid what are perfect bear-market conditions. And once again the bulls will be proven wrong because 2003 will be the fourth-straight down year for the stock market. In fact, the Dow and the S&P 500 would need to fall at least another 15% apiece to become reasonably valued, while the Nasdaq needs to shed 300 points from here to find a floor. And there will be much else beyond lackluster earnings and pricey valuations to unnerve investors next year. Here's a short list: more accounting scandals, a weak dollar, a panicky central bank, problems in foreign economies and the little matter of a shooting war in the Middle East.
First, earnings. This year, it's been very hard to see what companies are actually making, due to the heavy use of restructuring charges. Companies can bury core expenses in these charges. Wall Street follows something shady called operating earnings, which generally leave out charges. Operating earnings are predicted at $47.17 for the S&P 500 in 2002, way higher than the $31.69 for net earnings, which include charges and other items. A midpoint between those two numbers -- $39.43 -- would give a rough approximation for real operating earnings. Boost it by a generous 15% to reflect an earnings recovery in 2003, and the S&P 500's true profits next year could be $45.35. If we say stocks should trade at 15 to 16 times that number -- again, charitable -- the S&P 500 index would be fairly valued at between 680 and 725. Outlandishly low? Not when you consider stocks touched 769 this year. The index has recently been around 880.