By James Langton

(April 17 – 16:30 ET) – Market strategists continue to puzzle over the future direction of the U.S. stock market, offering widely divergent calls.

Deutsche Bank Alex Brown chief investment strategist Ed Yardeni notes that current conditions suggest a move to 1,300 for the S&P 500 from its current level of about 1,200. Although if historical norms are to prevail, a move to 975, or lower, could be in the cards.

Yardeni says his secret formula for forecasting the stock market is to look at the 12-month forward consensus expected earnings, not actual or trailing earnings, multiplied by the market’s P/E ratio. He uses the reciprocal of the 10-year Treasury bond yield as the best proxy for the fair-value forward P/E.

With the yield at about 5%, this implies a P/E of 20. “It doesn’t have to be 20, but historically the actual P/E tends to track the fair-value remarkably well.” Yardeni says that with the earnings consensus of industry analysts at $65 per share for 2002, if that remains their forecast at the end of the year and the P/E is still 20, then the S&P 500 would rise to 1,300.

“I think this is a reasonable forecast for the market at the end of the year, though my guess is that analysts will be using a lower P/E for 2002, but the valuation multiple might be a bit higher. I know that several bullish strategists have more optimistic year-end targets like 1,500 or even 1,600. I am not saying they are wrong. I am saying that they must be more bullish on the outlook for earnings and valuation than I am at this time.”

Yardeni notes that the historical average P/E is about 10-15. Using 15 and $65 a share for earnings, the year-end S&P 500 would fall to 975, a 17% plunge. Although, he says bears “would also use a lower earnings forecast since they also anticipate that the economy is either in a recession or will soon be there”.

Christine Callies, chief U.S. investment strategist for Merrill Lynch, suggests keeping an eye on commodity markets for cues about the economy and stock markets. “Rate increases at the long end of the Treasury market appear to be pricing in a trough in economic activity,” she says. “Yesterday’s increases in spot metals prices also suggest that the economic malaise is not feeding on itself and may be reaching a low point. Commodity prices have also shown a particular tendency to improve after soft economic landings.”

Merrill is lowering its call on the S&P from 1,625 to 1,570, remaining in the bullish camp. “Because equity market leadership can adopt two different core themes coming out of an economic slowdown, investors need to be aware of the economic opinions of other asset classes,” says Callies. “If the lift in industrial metals proves to be more than temporary or more than is justified by localized production shutdowns, then the equity markets may shift quickly to a cyclical growth focus.”

In this scenario, she says economically-sensitive, high-operating-leverage segments of the S&P, such as basic materials and capital goods would likely lead the way higher, rather than financials, consumer cyclicals, consumer staples, or health care.