We noticed that warnings about a severe stock market decline are now coming from some of the more established institutions of the world. The Royal Bank of Scotland issued a stark warning to investors yesterday. The London Telegraph reported that RBS warned investors that global stock and credit markets could be on the verge of a steep market sell-off as central banks have their hands tied by soaring inflation. "A very nasty period is soon to be upon us - be prepared," Bob Janjuah, strategists at RBS told the paper. The S&P 500 index is likely to slump by more than 300 points by September as "all the chickens come home to roost" from over-easy lending practices and other excesses of the global boom period, the report quoted by the Telegraph said. Shorter term they seem to think the market will head higher into July and start the decline in early July.
The larger established institutions in the U.S. that we know are almost as bearish as we are, talk with bearish sound bites, but then state their neutrality when asked about the market direction. Just so we make ourselves clear on our position, we are more bearish than RBS, but do not claim to be able to call near term swings in the market as they just did. We do think the S&P 500 will trade at around 10 times the last 12 months "reported" earnings before this bear market ends. The last 12 months of "reported" earnings are about $60 and the estimate for 2008 is $72.56 by the S&P analysts, while the estimate for 2009 is just over $70. We are sure that the analysts won't be on target (they never are) and if we had to guess we would think that both estimates are high. The bottom line is that we believe the S&P 500 will trade below 800 within the next year or so and could trade below 700. We know that may come as a shock to some newer viewers, but historically major bear markets (which we believe we are in now) usually don't bottom out above 10 times earnings.
The other difference we have with the RBS report is that we are not hanging our hats on the inflation problem (especially energy) being the main cause of the bear market. We still believe strongly that the housing deflation in the U.S. will be the strongest force for a severe consumer driven recession. Secondly, the headwinds we discussed in the May 15th comment was led by the high commodity prices driven by easy money and lack of a comprehensive energy policy in the U.S.
President Bush spoke to the energy policy June 18th. He asked congress to end the ban on offshore oil drilling. He would like to drill oil wells in the Outer Continental Shelf (OCS) claiming that if the 1981 ban against this drilling were overturned, it would generate 18 billion barrels of oil-equivalent to 10 years of current U.S. oil production.
Clearly, the President and his advisors did not hear what Jim Tisch, CEO of Loews Corporation, had to say about the subject on Tuesday morning on CNBC. Jim stated at the end of Squawk Box that there are no more rigs available, and the ones that are available are extremely costly. He stated, "Demand for sophisticated rigs is going through the roof. They were $30,000 4 years ago and the strong demand for them has driven the day rates up to $300,000 to $400,000 presently. It takes 3 to 4 years to build the rigs and the costs are $700,000,000 to $800,000,000 apiece. In order to spend that much money the builder would have to anticipate receiving $500,000--$600,000 a day to justify the expenditure. To find one well in the ocean (10,000 feet deep) it would cost around $150 million." Maybe Jim should try to get the President's ear.
Not only was the President not aware of the costs of drilling offshore, his estimate of the 18 billion barrels of oil was exaggerated by about 6 times according to David Kirsch of PFC Energy. We will have to add this enormous cost of drilling for offshore oil to our list of Headwinds that, as we said before, were hurricane force winds already.