Dimming recovery hopes make market bottom elusive DAVID BERMAN February 24, 2009

If you were waiting for beaten-up U.S. financial stocks to lead the stock market out of its malaise, here’s some bad news: Citigroup Inc. and Bank of America Corp. rose yesterday, but the rest of the market ran in the opposite direction, sending the S&P 500 to its lowest close since 1997.

The Dow Jones industrial average also fell close to a 12-year low as investors faced the prospect that widespread projections for an economic recovery in the second half of the year are now looking increasingly far-fetched.

"The problem is that the same people who missed the recession in the first place and have only recently admitted that we’re going to have a mild-to-moderate recession are still behind the curve," said Barry Ritholtz, chief executive and director of equity research at Fusion IQ in New York. "They still haven’t figured out that this is going to be a damned bad recession."

Investors, it seems, have figured this out. The Dow closed at 7,114.78, down 250.89 points or 3.4 per cent. The broader S&P 500 closed at 743.33, down 26.72 points or 3.5 per cent - its sixth loss in a row. The miserable day erased the Nov. 20 floor that had given some investors hope that the worst of the recent stock market selloff was behind them and some sort of recovery was in the works.

Things are so bad that Bespoke Investment Group noted that 134 companies in the S&P 500 - or nearly 27 per cent of its members - no longer qualify for inclusion in the index because the total value of their shares sit below $3-billion (U.S.).

"The market is not going to get anything going until we get the financials to at least stabilize," said Marc Pado, chief market strategist at Cantor Fitzgerald. "They don’t have to lead the market on the upside, but they do have to stabilize, and we’re not at that point yet."

Bank of America and Citigroup rose 3.2 and 9.7 per cent, respectively - the only two stocks in the 30-member Dow to end the day higher - but Mr. Pado said the modest bounce was simply due to some relief that the U.S. administration has asserted it does not want to nationalize either bank. The broader S&P 500 financials subindex actually fell 3.5 per cent.

Meanwhile, big-name technology stocks, such as International Business Machines Corp., Intel Corp. and Hewlett-Packard Co. were walloped on concerns that they are particularly susceptible to the weaker economy because beleaguered companies will cut back on their capital expenditures this year, translating into weaker earnings.

If the stock market is a reflection of earnings expectations, and those expectations are constantly being ratcheted down, then it is little wonder that volatility persists.

Mr. Ritholtz noted that 2008 began with analysts expecting earnings of $105 a share for the S&P 500. Turns out, they were closer to $65 - and he believes 2009 earnings are likely to fall again, to about $50 in 2009. If the market values them at a typical bull market multiple of 15-times earnings, then the S&P 500 should trade at about 750, or roughly where it is today.

"But we’re not in a bull market," he said. "What we’ve seen in the bear markets of the past is that multiples contract, and people aren’t willing to pay $15 for $1 of earnings. They’re willing to pay $12 or $10."

That gets the S&P 500 trading between 500 and 600 - or well below the current level. Pessimistic? You bet. But if more investors push back expectations of an economic recovery to 2010 or 2011, it is going to be awfully hard to call a long-lasting stock market bottom.

See David Berman’s Market