Monday, February 2, 2009

Barclays Douses Market's Rally Expecations

Barclays/Lehman chief market strategist Barry Knapp came out with a report this weekend predicting a 10% drop for the S&P in this quarter, with a low of 750 to come soon. Why the pessimism? As Barry succinctly puts it "We were recently asked - Isn't all the bad news out? Unfortunately, we believe the answer is - No."

The report mentions Lehman's S&P 2009 Earnings expectation which is at 46, not surprisingly lower than Goldman which is never known for trying sell optimism to potential clients.

While Barry puts a lot of the blame on Fed's lack of a clearcut policy, the main reasons for his bleak view are the following:

1) The complexities associated with setting up a "Bad Bank" are likely to drag the process out for months;

2) The FOMC directive, rather than taking the next step in resolving the issue of historically wide credit spreads (as we had hoped), suggests dissension on the part of the Regional Bank Presidents. Richmond Fed President Lacker's dissent, along with the language about cautious use of the Fed's balance sheet, points to the FOMC's concerns regarding credit risk;

3) Another wave of weak macroeconomic data seems highly probable over the coming weeks, in our view. While expectations have been reset significantly lower, the data are still unequivocally negative. Global aggregate demand dropped sharply in December, and January doesn't look much better. Admittedly, there have been some hints that manufacturing inventory destocking may have overshot, at least in the short term;

4) Earnings estimates are still too high, in our opinion. The topic of bank nationalization has overshadowed a 31.5% y/y decline in 4Q08 S&P 500 earnings that, if maintained for the balance of the year, would produce an earnings number close to our -21% estimate of $46 for 2009. Other top-down strategists are catching on and estimates are falling quickly, as are bottom-up analyst forecasts. We have heard some discussion that the market will begin to shift focus to 2010. We reject this logic. Until there is greater certainty as to whether there will be a second half economic recovery, we believe the focus will remain on 2009. The FOMC's directive described the outlook as "a gradual recovery in economic activity [that] will begin later this year, but the downside risks to that outlook are significant." Additionally, in a recent European road show, we talked to roughly 250 investors and received virtually no push back on our forecasts. Perhaps they were just being polite, but our sense is that most agreed with us.
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