Every week one or two different people, not always the same ones, forward me the latest missive from John Mauldin of Millenium Wave Advisors, LLC.  This is no surprise, since he claims to have over 1.5 million subscribers. Thanks for thinking of me, guys, but I’m a subscriber myself. I like how he presents ideas from this and that analyst and money manager, and it’s important to read popular writers to stay on top of the zeitgeist.

Mauldin’s catch phrase of late has been ‘muddle through,’ as he has been strolling through the wreckage of the economy with rose colored glasses on. All last year, he was making the case that we would only experience a mild recession and period of below-trend growth, and that a major bear market was not in the cards. For instance, here is presenting the old decoupling case:

“It is going to take some time for the economy to work itself through the current credit crisis and the collapse of the housing bubble. I suspect the US economy will grow below trend for at least another year. We will work through it, as we always do. But it is the return of the Muddle Through Economy….

The sectors that are outperforming are all large multi-nationals that get as much as 50% of their earnings from outside the US, and the global economy is doing well. Those that are not doing well are tied to US domestic consumer spending and the financials…

If we saw a 30% drop in the 40% domestically impacted sectors (with healthcare and utilities basically flat) and a 10% rise in the rest, that would be an overall drop of only about 7%, which is not much of a bear market in the total index, although there would be sectors that are ugly.”

So it was with some satisfaction this morning when I read Mr. Mauldin’s “correction” of his January 2008 predictions (he first re-prints his old predictions, then updates them):

” “So let’s get to the predictions. I think that we are in a recession for most of the first half of this year, and that we begin a slow recovery in the second half. It will be a Muddle Through Economy for at least another year after that. That would suggest that most companies will come under serious earnings pressure. If history is any indicator, that means we should see a bear market in the first half of this year. How deep will depend on how fast the Fed cuts, but I don’t think we are looking at anything close to the bear market of 2000-2001. Still, I wouldn’t want to stand in front of a bear market train.

“Consumer spending is going to slow, and it will be slower to rebound, for reasons outlined above. That will also make the recovery in the stock market a little slower. But I expect to become bullish on the market sometime this summer, if not before. I’m looking forward to it.”

To be blunt, that optimism now seems misplaced. I think we are likely to stay in recession for perhaps the rest of the year and well into 2009 before we start a very slow recovery. It is not time to get bullish on stocks, as I have been writing for the past few months. Earnings are going to continue to come under pressure, and earnings are what drive the stock market over the long term. We could see total S&P 500 as-reported earnings drop below $50. You do the math. Even with a 20 multiple, that does not yield a pretty picture.

I think we are going to test the recent lows and then watch the market go lower as the market gets disappointed in the earnings from the third quarter, and re-test those lows again. We are in for an extended period of Muddle Through, while we wait for the housing market to find a bottom and the credit crisis to abate.”

To be blunt, that optimism now seems misplaced. I think we are likely to stay in recession for perhaps the rest of the year and well into 2009 before we start a very slow recovery. It is not time to get bullish on stocks, as I have been writing for the past few months. Earnings are going to continue to come under pressure, and earnings are what drive the stock market over the long term. We could see total S&P 500 as-reported earnings drop below $50. You do the math. Even with a 20 multiple, that does not yield a pretty picture.

I think we are going to test the recent lows and then watch the market go lower as the market gets disappointed in the earnings from the third quarter, and re-test those lows again. We are in for an extended period of Muddle Through, while we wait for the housing market to find a bottom and the credit crisis to abate.”

Mauldin today even seems to repudiate decoupling, as he quotes Desmond Lachman of the AEI:

“… The ‘decoupling’ optimists are ever hopeful that China’s rapid growth, together with the rest of Asia’s emerging market economies, will offset any U.S. economic downturn. But they tend to forget that Asia is filled with export-dependent economies: in some countries, exports to the United States alone [emphasis mine] account for more than 10 percent of annual GDP. The “decouplers” also forget how relatively small these Asian economies still are, at least in relation to the G-7 industrialized economies. Even the vaunted Chinese economy is barely 15 percent the size of the U.S. economy.”

So here we are in August 2008: Housing prices are down 20% nationwide, Bear Stearns has collapsed,  bank runs have begun, Fannie and Freddie have been bailed out, global stock markets are down 20%, the commodities indexes are down about 25% from their peak in June, and even John Mauldin admits that S&P 500 earnings could fall to $50.

That last bit is the scarriest, since if Mauldin is thinking $50, who knows how low they can go? And by the way, the median bear market PE is not 20, it’s 10.