The price-to-peak earnings multiple has climbed to 12x as of Friday’s close. Stocks reveled because of positive earnings releases that pushed the market higher by 4.5% and ended the declines of the prior two weeks. Alcoa (AA) started off the Dow Industrials earnings season with a strong showing, posting an unexpected net profit. We also believe that the reaction to the PepsiCo (PEP) earnings beat proved that the bar has been raised for the third quarter. Pepsi was able to beat on earnings, but the market was unimpressed by its revenue results, which came in a little light. Simply exceeding expectations on the bottom line may not be enough this quarter; the market needs to see real signs of growth and that often means revenue growth.
The week ahead should be extremely enlightening as bellwethers such as IBM (IBM), Intel (INTC), and Johnson & Johnson (JNJ) will announce. Analysts have been raising expectations in anticipation of a solid third quarter earnings season. Barring something unforeseen, these reports should provide a decent read on the overall economy as we expect to see the start of an economic recovery. However, at Ockham we will be most interest in seeing profit reports from the large financials because they are really a wild card. The financials have been highly volatile and their earnings capacity going forward should start to come into better focus. Among these crucial reports will be Bank of America (BAC), Citigroup (C) and JP Morgan (JPM). Also, General Electric (GE) which is a hybrid financial and industrial company will also be highly anticipated.
The percentage of NYSE stocks selling above their 30-week moving average remains elevated at nearly 90%. We continue to be impressed by the strength of investor sentiment, especially in the face of some extremely strong headwinds. We cannot recall a time that this measure of sentiment, first used by Investors Intelligence, has swung so rapidly from down in the dumps to sky high. Money has flooded into equities at least partially because of a lack of attractive alternatives in terms of asset classes, and the investing community has seen a rise in their appetite for risk. We prefer to err on the side of caution when the market is showing what we would refer to as irrational exuberance.
For the first time since December of 2007–incidentally the recognized beginning of the recession–the S&P 500 turned positive on a trailing twelve month basis. There was a massive decline in the market a year ago with the turmoil in the financial sector, which makes the last year’s gain substantial at 19%. As we referenced in our blog last week, David Malpass wrote a brilliant Op-Ed in the Wall Street Journal on Thursday which showed that much of the market’s performance has been pumped up by the falling dollar. When you look value the S&P 500 in Euros the performance becomes much less impressive. We do not expect the quantitative easing to slow down in the U.S. in the near future, and Australia became the first major economy to raise interest rates since the global recession hit. This weak dollar policy should benefit those companies that get the bulk of their sales overseas, but as Malpass argues, this is a very dangerous policy for the health of our nation’s economy for the long-term.