The price-to-peak earnings multiple has topped 12x as of Friday’s close. The market has clearly recovered from the March lows, at which point, we were advising long term investors to be fully invested. As the cloud of uncertainty hovering over the economy persisted and grew, the market’s valuation reflected this uncertainty. At the same time, investor sentiment was down in the dumps. Investors had lost their will to hold equities that were reaching their lowest point in more than a decade. Our EIG from March 9th said,
“There had been hopes that the worst was behind us in 2008, but 2009 has begun with 8 out of 9 weeks in the red. At times like these, it helps to remind oneself that this condition cannot last indefinitely. Long term investors historically have done well to invest when things look bleak, valuations are depressed and sentiment is low. As Warren Buffet has said for years, “When others are greedy, be fearful. When others are fearful, be greedy.” It is this contrarian’s perspective that has enabled him to outpace the market’s performance consistently over the last 50 years. This strategy of being skeptical of prevailing conventional wisdom has proven its worth through investors like Buffet, and the current market’s conventional wisdom is decidedly bearish.” — Ockham’s EIG 3/9/2009
Part of being a value investors is taking a contrarian view and a healthy skeptical of the prevailing conventional wisdom. Our position in March (and February) was unpopular at the time, but the past few months have proved to be a powerful rally that investors will be kicking themselves if they missed.
Now, we are getting that same contrarian feeling gnawing at our gut. The rally has been extremely impressive, but we have to urge caution. Valuations are no longer particularly attractive, and there are nearly as high a percentage of bullish investment advisors as we saw in the summer of 2007. Be aware we are not market timers and we do not attempt to be.
The percentage of NYSE stocks selling above their 30-week moving average is up to 92.4% this week, which is nearing the highest level we have observed in the last 11 years. As we said before, surveys of investment advisors are showing they are exceedingly bullish, and AAII’s survey of individual investors shows the bulls are more prevalent than bears. Even Fed Chairman Ben Bernanke, has gone on record saying the recession is over, “from a technical perspective.” Clearly, investor sentiment is optimistic for the future, but we often view this as a contrarian indicator. The wild card, as we see it, is the flow of money back into equities from those that were left out of the rally and are now chasing returns.
With the outstanding performance of equities over the past six-plus months, we believe that few will argue the market appears overbought. Historically speaking, when extremely bullish sentiment is combined with overbought and moderately overvalued equities, on average this condition does not provide a sufficiently attractive risk/return profile.
It is now more than a year since collapse of Lehman Brothers when the financial system was in complete disarray. The bailouts and credit crisis develeraging that ensued suggested to many market observers that these problem may take years to unravel. Now, only a year later the market has advanced based on stabilized earnings and improving but often still weak macroeconomic data. As is often the case, Dr. John Hussman makes this point as clearly as any economist today.
“My discomfort about strenuously overbought and moderately overvalued conditions overlaps with skepticism about the U.S. economic “recovery,” which appears to be nothing but an artifact of government spending, while intrinsic economic activity remains weak. Stimulus induced “strength” is unlikely to propagate because, as I’ve noted before, economic recoveries are invariably led by expansion in debt-financed forms of spending such as gross domestic investment and durable goods. These classes of spending tend to lead other forms of economic activity by nearly a year, and it is difficult to expect this in an environment of heavy continued deleveraging pressure. Rather than abating, foreclosures and mortgage delinquencies are setting further records (pressured even more by continued net job losses), and we have now hit the point where Alt-A and Option-ARM resets are beginning (after a lull in the reset schedule since March). We know that post-crash markets feature partial recoveries followed by a very extended period of sideways movement. To expect an entirely different result in this instance – to assume that this is a typical post-war recovery and that everything is back to normal – seems hopeful to say the least.” — Hussman Funds, Weekly Market Comment 9/21/2009
