Dow Futures Down 350, Europe/Asia Smashed

Henry Blodget | January 21, 2008 9:15 AM

Europe's down about 6%, Japan fell 4%, and Dow futures are down 350 or so. Still 24 hours before the market opens, so plenty of time for a (temporary) bounce, but regardless of what happens tomorrow, it's increasingly clear that our credit-fueled dream years are rapidly coming to an end.

Hard to say which would be worse: A sudden 2,000-3,000 Dow drop to the past century's average valuation level*--or a grinding, gut-wrenching slog of head-fakes, dashed hopes, and ever-spreading depression. Either is possible (as, we suppose, is a sudden recovery, but we're hard-pressed to find a fundamental explanation for that one).

*Your broker, like one of ours, is no doubt excited to report that stocks are now a great buy because the S&P 500 P/E is now about in line with the long-term average of about 15X. There are a few problems with this analysis.

Profit margins are still at a cyclical high. When they regress to the long-term mean (which they will unless "it's different this time"), earnings will drop, and the P/E will look much higher.
Your broker is almost certainly referring to "forward operating earnings," which are quite different than trailing actual earnings. That 15X "average" multiple is based on the latter. The long-term average multiple on forward earnings is lower.
"Operating earnings" don't include all the massive write-downs firms are being forced to take as they realize that their balance sheets are overloaded with crap.
"Average" does not mean "cheap." The reason 15X is the average is that stocks have spent about half of the last century below that number. "Cheap" would be about 10X.
Interest rates are irrelevant. Yes, there has been a recent correlation between interest rates and P/Es, but extend your analysis back more than 10-20 years, and the correlation disappears.

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