The price-to-peak earnings multiple has advanced to 12.8x as of Friday’s close. The market shook off disappointingly poor job loss data on Friday and extended the equity market’s strong weekly gain. The Labor Department report showed nonfarm payrolls shrunk by 85,000 in December, which was clearly worse than economists’ consensus estimates of net job growth. According to the report, the labor market shrunk by 661,000 workers during the past month, which left the traditional unemployment rate unchanged at about 10%. The U6 rate, which includes discouraged workers no longer actively seeking work, increased in December to 17.3%. We were surprised by the markets sanguine response to the still contracting labor market; at present, stock investors have fully embraced the belief that the recession is over and we’re in an economic recovery–albeit a jobless one. For now it appears that the market is unconcerned about the bleak employment situation, possibly because employment is typically a lagging indicator.
Fourth quarter earnings season unofficially starts after the close today with the fourth quarter 2009 report from Dow component Alcoa (AA). Analysts have raised market-wide earnings projections many times over the past year and current figures are likely now at a level that will be an appropriate measuring stick. The financial sector has obviously been the most volatile of all sectors; so if you normalize the estimates by removing financials, most analysts anticipate earnings growth of 8% or more for 2010.
The percentage of NYSE stocks selling above their 30-week moving average rose to 87% at the end of last week. As you can see from the sentiment chart below, the bulls are in control at this time. With fourth quarter earnings set to begin rolling in on a daily basis going forward, we are curious as to whether bulls will be able to prevail after the fourth quarter 2009 numbers are digested. Given how bleak the fourth quarter of 2008 was, the comparisons for this quarter should be very favorable. With sentiment being so overwhelmingly bullish, there is some risk that no amount of good news in the numbers will be enough to please stock investors. Undoubtedly over the past three quarters we have seen the market react to different components of corporate earnings. Generally speaking, reports for the first three months of 2009 were met with a sense of relief as there were fewer write-downs and the crisis…
plaguing the financial sector seemed to be abating. In the second reporting period, most analysts’ estimates were too bearish as cost-cutting allowed the vast majority (nearly 80%) of companies to beat those predictions. By the third round of earnings last year, stocks had enjoyed a strong rally and investors wanted to see top-line growth in order to justify the gains.
For this quarter, solid performance in all of the standard fundamental metrics such as revenue, earnings, growth, margin, etc. will be crucial. However, we think this earnings season may rely upon something harder to quantify: tone and language used in corporate guidance and outlook for 2010. If corporate management espouses positive and optimistic views for 2010, stock investors will likely be comfortable with current and higher valuations. We are anxious to gauge how executives view their businesses for the coming year, especially since corporate insiders have been selling stock in huge amounts for some time. For example, one week in early December, corporate insiders sold 82x more shares than they purchased in dollar volume terms. While management will almost certainly present an optimistic tone in quarterly conference calls, a far more reliable indicator of their personal outlook is whether they are adding to or shrinking their own stock positions.
We continue to advise a defensive posture towards the equity market at this juncture. For the long-term investor, we believe valuation is slightly unfavorable as stocks have been buoyed by extremely bullish sentiment. As with each of the past three quarters, the market will require a higher standard of proof that the economy is healthy than was the case in the prior quarter. Some macroeconomic factors have undoubtedly turned bullish but, as of the start of 2010 joblessness, remains a persistent issue that should not be ignored. 17.3% of the workforce either unemployed or underemployed means that nearly one-fifth of consumers are spending minimally, struggling to stay in their homes, and probably adding to their personal debt—while their risk of default grows. This is not an optimal situation for deploying additional resources to stocks, but rather a time to take some profits and focus more on stable, income-producing stocks.
