Yesterday was certainly a wild day in the market, with the Dow down almost 1,000 points at one point, including a heart stopping 700-point decline in the middle of the day over the course of only about five minutes. The market quickly recovered from that drop, but was still very weak and ended the day lower by 347.80 points or 3.2%.
The 700 point intra day swing is still being investigated, but was probably the result of someone mistakenly punching in a “b” when they meant to punch in a “m” and, thus, instead of selling $15 million worth of stock, they sold $15 billion. That then set off a cascade of orders, many of them from individual investors that were using trailing stop loss orders. This is a very good reason NOT to rely on mechanical stop loss orders, as many people ended up selling out of perfectly good stocks at very low prices, which went right back up within a few minutes. The incident has raised some serious questions about just how worthwhile all this hyper-active computer trading really is.
The New York Stock Exchange, where there are still specialists on the floor, had the good sense to slow down trading a bit. As a result, one of the poster children for the intraday craziness, Proctor & Gamble (PG), never traded below $56 on the floor of the NYSE, even though in markets it fell below $40 from over $60 for a few minutes before recovering most of the loss. Some trades in stocks that plunged and then recovered by more than 60% were busted by the exchange and by NASDAQ (as if they never happened). It is not that much comfort for someone who got stopped out 59% below where the stock had been trading just a few minutes before.
P&G wasn’t even the worst case. Accenture (ACN), the big consulting firm, plunged from over $40 to just $0.01 before rebounding. The authorities really have to review their procedures so that something like this does not happen again.
On the other hand, if you own P&G and were not using trailing stop loss orders, why should it really make any difference to you if the stock went on sale for a few minutes during the day? After all, the reason you bought P&G was probably that it is a strong company with a huge collection of strong stable brands that throw off lots of cash flow that can be used to pay out dividends. If you really are an investor in P&G, rather than just speculating, such wild moves during the day should be totally irrelevant to you.
However, what about the 347.80 point loss on the day? That really is a separate issue from the fat fingers and the potential computer glitches. That is more related to the problems with Greece and potential contagion to the rest of Europe, particularly those on the southern tier of Europe. That is a real concern. After all, it was the contagion from the demise of Lehman Brothers that almost brought the entire world economy to its knees in the fall of 2008. Is it likely to happen again? It’s possible but not likely, and would really require an incredible amount of incompetence on the part of European leaders, most notably the European Central Bank (OK, maybe it will happen again).
There are however some very real and very significant differences between now and the fall of 2008. Let’s take a look at conditions at the start of August 2008, which was just about at the same point in the 2Q08 earnings season that we are at now in terms of the 1Q10 earnings season. Remember, this is well before the news of Lehman’s problems broke, while the Greek problems have been dominating the news for several weeks now.
Then, positive surprises were coming in at a ratio of 2.47:1 over disappointments, which is below the historical average of about 3:1 of positive over negative surprises. Similarly, the median surprise was a distinctly mediocre 3.33%. Year-over-year earnings growth among the firms that had reported was running at 10.6%. Analysts were actually making slightly more cuts in their earnings forecasts for both 2008 and 2009 than they were increasing estimates. In the real economy, employment had been falling for eight straight months. Banks were leveraged up to their eyeballs (and much more leveraged than their official financial statement let on due to things like Special Investment Vehicles, or SIVs, which were designed to hide how much debt they really had, and were playing games where they would offload some of their debt to a friendly hedge fund for a few days right around their reporting time).
Conditions are very different right now. So far, positive surprises are simply beating the pants off of disappointments by a ratio of 4.75:1, and the median surprise is far above average at 6.90%. Year-over-year earnings growth is an extremely strong 45.4%. Unlike the fourth quarter, when the year-over-year earnings gains were even stronger at 126.16% (among those firms that have already reported), the growth is not just a function of financials rebounding from a disastrous year-ago quarter. If one strips out the financials, earnings growth has actually accelerated to 40.8% from 13.6% in the fourth quarter.
Yes, stocks have run up a long way from the bottom in March of 2009, but P/E ratios are still quite reasonable. Based on the current forecasts for 2010 earnings, the S&P 500 is now trading for 14.1x 2010 earnings, and for 12.0x 2011 earnings estimates. Back at the start of August 2008, the market was trading for 14.4x the then current estimates for 2008 and 11.8x the estimates (which proved to be FAR too high) for 2009. In addition, the ten year T-note was yielding 3.95% then, and it is yielding 3.41% now. Lower risk free rates call for higher, not lower P/E ratios. In the three months leading up to that point in 2008, the economy had lost 737,000 jobs. Over the last three months, the economy has gained 559,000 jobs.
In short, the U.S. economy is headed in a much better direction now than it was then. Ultimately the value of stocks is about the level of earnings they can achieve and how much they can grow them over time. In a strong and improving economy, companies will generate far more earnings than they will in a weak economy. Those future earnings have to be discounted back to the present by the prevailing level of interest rates. Rising earnings estimates should give you confidence that at least the current expected levels of earnings will be achieved, while falling earnings estimates should give you pause.
What is going on in Greece is not irrelevant. The strength of the dollar that the Greek drama has caused does have the potential to hurt U.S. stocks, through lower exports and cheaper imports that compete with their goods as well as from translating the earnings of their overseas operations at more adverse rates.
Still, this is not likely to be a repeat of late 2008. This is a correction in the bull market, not the start of a new bear market. Calm down, take a deep breath, and see if you want to swap out of some of your current stocks in favor of some bargains that have become available because of this. However, this is not the time to sell everything and head for the hills.
Read the full analyst report on “PG”
Read the full analyst report on “ACN”
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