Why the S&P 500 Could Fall Another 20% in 2011

S&P 500 Forecast 2011
S&P 500 Forecast 2011

It seems impossible that the S&P 500 could drop another 20% to 1,000 on top of its losses of the last week, but the index was that low as recently as last July, and some of the things that pushed the S&P down then -- after it had advanced consistently from a March 2009 trough -- could happen again. The S&P 500 currently trades at 1,280 against a 52-week high of 1,370 reached late in April.

Many analysts say that the stock market trades based on forecasts of how earnings and the economy will be six months into the future. Investors looking at those prospects for year's end may not like what they see.

The primary driver of the market is generally corporate earnings. Companies were supposed to have strong revenue recoveries as the economy improved. Many had maintained profit margins during the recession by cutting costs. Much of that cost-cutting was accomplished through layoffs, which was a primary reason unemployment grew so much two years ago and has stayed fairly high. But cost cuts are typically one time events. That means many companies do not have the flexibility to drive down their costs again.

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Another factor which will likely harm margins at many companies are the increases in gas and other commodities prices. Tech companies in the S&P like Apple (AAPL) and Microsoft (MSFT) are largely immune to the price of gas. But the index is also heavy with retailers like Walmart (WMT) and Target (TGT), companies that must deal with higher shipping costs and pressure from the prices of raw materials like wool and cotton. Firms like General Mills (GIS) and Proctor & Gamble (PG) are also dealing with the higher prices for key ingredients in the products that they make and market.

Top-line growth for many of the S&P 500 firms will also be an issue. The economy has clearly slowed again -- mostly due to persistent high unemployment and faltering consumer spending. The anticipated 2011 surge in corporate sales is not likely to happen in many sectors.

Poor factory orders and weak job creation helped push the S&P down to the vicinity of 1,000 last July, and both are concerns again. If jobs, consumer spending, and manufacturing strength are the critical drivers of the market, we may not see much ebullience on Wall Street for the balance of 2011.

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