Market is pricing in a quick recovery

The stock market is shrugging off massive writedowns by banks and brokerage firms. In the beginning of this month when UBS wrote off $19 billion in bad debt, the stock market had a strong rally. The stock market is pricing in that the worst is over. Here is a chart of the S&P 500’s earnings over the last 20 years. Earnings peaked in Q3 2007 and fell sharply as banks and brokerages took a lot of mark-downs. Over 20% of the S&P 500 companies have reported already. Earnings have been on average better than last quarter. The majority of banks and brokerages have already reported for this quarter, so it looks like Q1 2008 will rebound from the lows reached last quarter. In fact, according to the earnings estimates, the market is pricing in that Q2 2008 will be higher than the highs reached in Q3 2007. The market is then estimating that earnings will then regain their old form and continue accelerating higher at a rapid pace.This would be a very fast recovery. After the recession in 1990, it took 4 years for the market to surpass the highs reached before the recession. After the recession in 2001, it took the market 3.5 years to surpass the highs.

I think it is too early to call a bottom in the financial crisis. Housing prices are declining at an accelerating pace. Delinquencies and Foreclosures are also surging.

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