[T.S.R:17997] Citi: Stocks Have Not Priced In A Financial Crisis As Yet!

At 1.5X Book and 9.4X FY12 Earnings, Equities are pricing in a probable recession, but possibly ignoring a financial crisis. Should a financial crisis unveil ultimately, equities would quote at least 30 per cent lower from current levels or at just 1X Book. Investors, may just as well brace for that eventuality.

 

European sovereign credit crisis resolution still seems distant.

While most investors and policy makers expect a coalescence of government leaders and central bankers to arrange a plan that prevents a collapse of the eurozone, a comprehensive solution does not seem likely in the near term, in our view. The "muddle through" option seems to translate into the kind of equity market spasms that the investment community is undergoing once again. 

Commodity price weakness may be starting to suggest something more ominous. There appears to be a bit more of a sinister element to the recent data, as commodity prices are now falling, led by copper, which is often perceived as an economic bellwether. Some of the weakness is related to softer data out of Europe and China, not to mention sluggish consumer confidence in the US, but a stronger US dollar is having some impact too. The underperformance of Materials stocks is not altogether surprising, as various factors have insinuated that an Underweight posture was appropriate. 

Money flows continue to shy away from equities. Mutual fund flows remain fairly negative as investors react to the tougher equity market, reminding portfolio managers that sour sentiment is being matched by the investing public acting with their pocketbooks. Negative sentiment is often a useful contrarian indicator but picking the exact moment of it turning remains elusive. 

Stock prices already are assuming much weaker profit trends. In many respects, the S&P 500 appears to be reflecting the potential for 2012 EPS to drop to around the $75 area, which we consider overly pessimistic. One cannot ignore the near 10% S&P 500 sales exposure to Europe, and its economic woes plus seemingly peak margins, but the kind of earnings breakdown being considered implies a far more severe cyclical shift than the data intimates, in our view. 

Balance sheet health and credit environment is far better than 2008. The credit situation is nowhere near the 2007-08 environment and corporate balance sheets are much stronger now as well, which argues that the sell-off in markets may be overdone.

Furthermore, the US banking sector does not have to repeat the securitization writeoffs that crushed S&P 500 EPS.

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