Evaporated earnings show that even inflation cannot help the S&P 500 avoid more declines once the rally is over

Many investors, traders and analysts are turning more positive with the rally sparked by the Fed's announcement last week. Ironically, the idea of the Fed buying huge quantities of Treasury debt has long been expected by forward-projecting theorists. And the thinking has been that when it would come, such a move would be a harbinger confirming the economy's financial dire straits. So the idea that it would be bullish doesn't really make fundamental sense. It looks like a desperate ploy to spark inflation to help boost the markets. Perhaps a weaker dollar will help boost earnings. But earnings have dropped so precipitously that it's freaky to imagine the level of inflation that would be required to boost the markets seriously. This week's free "Chart of the Day" which you can get on their no-charge mailing list, at http://www.chartoftheday.com/20090320.htm?T graphically illustrates how far earnings have fallen on a real (inflation-adjusted) basis:

"Chart of the Day

"It's no secret that it's bad out there. Today's chart helps provide some perspective as to the magnitude of the current economic decline. Today's chart illustrates that 12-month, as-reported S&P 500 earnings have declined over 80% over the past 18 months, making this by far the largest decline on record (the data goes back to 1936). In fact, real earnings have dropped to a level not seen since the 1930s and 40s – the back end of the Great Depression. While earnings have been struggling since Q3 2007, it was the latest quarter (Q4 2008 the first full quarter following the financial meltdown), where the real damage was done. During Q4 2008, the S&P 500 came in with its first negative earnings quarter ever and the amount lost during the quarter was more than the index has ever earned during a single quarter."

Folks, with a real earnings chart that looks like that, it isn't so surprising to see the S&P 500 drop as shown on my weekly chart (below). And still, since we don't directly trade news but rather tracking where the market is going, I need to be open to the idea that the market doesn't necessarily have to finish going down to the lower channel line I marked on the chart. At least not right away. From a chart pattern perspective, Tony Caldaro is right - the market did put in a 5-wave looking pattern recently. So at least some level of a bear market rally should be respected. And the SPX did come within just a few dollars of one of my target levels, the $664 (it did get to $667) so I should not be stubborn about looking for lower immediately. Here's the chart:

Given that the indicators have moved to a more favorable position, I'll have to give the market some leeway to see if it wants to move in a bear market rally that could even play out for some weeks before another turn lower. Given how the earnings chart looks - and even recognizing that it's calculated in real, inflation-adjusted numbers - it's difficult to see how an argument could be made that the market has finished with all the downside movement it needs before it's finally finished with the bear market.

Don't get me wrong - I'm not going to hold short during any rally, since it's possible that we get a sharp movement up instead of a meandering, choppy, sideways market. If we see the market move above last week's highs, then levels such as 830 and 838 are the next places I'll look in the SPX for weakness. Above that, and the upper trendlines in my downtrend channel may come into play. Above those, if it happens, then the 200-day moving average as well as retracement levels such as Tony identifies in his weekend update. And Andre Gratian will be weighing in with his weekend analysis update tomorrow as well. So the bottom line for now is - I just cannot advocate to my family and friends that they consider the equities markets to be a safe investment!