Here are some scenarios where I could envision a large move lower:
- A lot of the current bullish factors are dependent on low interest rates. Companies are borrowing at record low rates to buy back shares, lower interest expense and to finance buyouts. The 2.5% dividend yield on stocks looks downright generous compared to bond yields. Consumers and home buyers take advantage of the low rates as well. If QEII or the threat of QEII sends the dollar lower and stokes inflation than rates are likely to go higher. Higher rates caused by stagflation would destroy the market. This is a huge risk that I believe the Fed is completely ignoring.
- While the economy has been slowing down at the pace I expected, I must admit that corporate profits have held up better than I expected under these conditions. If the slowdown starts to hit corporate profits and cash flows in a much larger way than the market would likely go significantly lower. Currently profit estimates for the S&P 500 for 2011 are approximately $95. It would take a 20% drop in profit expectations before valuations were seriously challenged.
- In a slowing global economy with many imbalances the "unexpected" happens more frequently. There clearly is higher than normal risk of an "unexpected" event.