The credit boom is still on schedule to collapse in early 2006, taking the economy and the stock market down with it. What's more, the stock market is starting to see that scenario as increasingly likely. Many expected 2005 to be the year when the economy turned in a robust performance, finally putting the destabilizing factors of the past five years -- overpriced assets, erratic demand, whipsawing consumer confidence and a gaping trade deficit -- in the rearview mirror. But for the economy to escape those things, it has to ditch its addiction to easy money in the very near future. And there is no sign of that happening as we approach the middle of this pivotal year. In fact, just the opposite has occurred. As hard as it may be to believe, nearly every key indicator shows that the dependence on credit has gotten markedly worse. And the stock market is obtaining an increasing distaste for the credit bubble, even though it has helped shore it up since 2001. The lackluster performance of market indices -- the S&P 500 is down 4% so far -- needs to be explained.
To do that, it's worth looking at valuation. The S&P 500 is trading at 15 times forecast 2005 earnings, which is cheap compared with the price-to-earnings ratios of the past eight years. With interest rates at low levels historically, this cheap-looking P/E ratio would normally provide the basis for a ferocious and sustained move upward in stocks. The fact that the indices have sagged suggests that the market sniffs real trouble around the corner. It might be that investors feel that analysts have overestimated the earnings being used in the P/E ratio calculation. But analysts always overestimate marketwide earnings, so something else must be spooking the market. That something is almost certainly the fear that the intoxicating fuel that has driven stocks higher in the past -- cheap credit -- will soon have to be switched off, either by the Fed or by banks that finally see the need to be more circumspect with their balance sheets.