The Elusive Bottom

We aren't past the halfway point of this recession

My sense is that we probably aren't even past the halfway point yet of this recession, the credit losses or the house price deflation. Looking at whether equities may have bottomed or not on an intermediate basis, maybe the recent action to the negative side was an important inflection. In terms of what I do, which is trying to tie the macro into the markets, I have a very tough time believing that we have reached anything close to a fundamental low, either in the S&P 500 or in the long-bond yield, for that matter.

300-point rallies in the Dow happen in bear markets

We're in a very confusing atmosphere. People didn't really know what to make of a 300-point rally in the Dow the other day, but my main message was that 300point rallies from the Dow don't happen in bull markets. In fact, they never happened in the bull market from October '02 to October '07, but it has happened 6 times in this bear market and happened 12 times in the last bear market. You don't get moves like that in bull markets. As Rich Bernstein has said time and again, "This is the hallmark of a recession and a hallmark of a bear market."

Profit as a share of GDP was at unheard of levels

The next question, of course, is what levels are we talking about? Again, I'm going to take what I do, which is earnings, and then talk about the appropriate multiple. What is the appropriate multiple at the low in a recession? In terms of earnings, I think that we have to understand where we're coming from in this cycle. We're coming from a situation where, because of all the leverage in the system, profits in the share of GDP went into this recession and bear market at 14% of GDP, which is unheard of. That's never happened before. A lot of the reason why profits soared was because everybody turned to financials. There was this tremendous amount of leverage, and that accounted for half of just about everything in the cycle from GDP growth to employment to profits.
The profits share of GDP, again, as a proxy for margins, is now down to 12%. Think about that for a second. This terrible earnings recession so far has taken the share of profits from 14% down to 12%. The question is, if I'm right on a recession, where does the profit share of GDP go to at a recession trough? Well, consistently it goes to 7%.

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