The price to peak earnings multiple held steady at 12.4x as of the close of last week’s trading. Stocks were little-changed last week as economic data was mixed: the trade deficit narrowed, jobless claims fell and the dollar strengthened. In general, we do not believe that the current price to peak earnings level is particularly worrisome, since the normal, historic range for this metric is between 12 and 15. However, when you look at the price to reported earnings multiple, the picture changes dramatically. Trailing twelve month reported earnings for companies in the S&P 500 currently stands at $11 per share, which is far below the peak earnings level of $89 hit in the summer of 2007. With the S&P 500 trading at a shade over 1100, the index’s trailing twelve reported earnings multiple stands at 100.6x!
Admittedly, reported earnings were skewed by large write-downs (primarily by financial firms) in last year’s fourth quarter. However, the effect of large third quarter 2008 write-downs are no longer being felt. Thus, while last year’s disastrous fourth quarter does account for some of this rather large 100.6x trailing twelve month reported earnings number, it does not fully explain it away and this metric does flash a warning to stock investors regarding overall market valuation.
The percentage of NYSE stocks trading above their 30-week moving average slipped a bit, finishing the week at 82%. This is still a relatively high level of sentiment and we would expect some moderation in this metric in the coming weeks. We are starting to see the bulls’ charge fizzle as the last four weeks have produced a tepid one percent rise in the S&P 500. Momentum has flattened considerably and volume has been uninspiring. Furthermore, over that same four week time frame, mutual fund investors have been net sellers of U.S. stock funds in favor of bond funds. Investment Company Institute (ICI) data shows an outflow of $10B from domestic equity funds while bond funds gained $37 billion in new capital. This data suggests that the average investor believes that stocks are unattractive at current levels, are taking profits and redeploying money to bonds.
While bulls may continue to drive equities higher over the short-term, we continue to believe that the risk/reward trade-off in this market is unappealing. At current levels, we believe the market has already baked-in a strong economic recovery; in fact, respected economist David Rosenberg suggests that at current levels, stocks valuations need to see GDP growth of of four percent for all of 2010. We are skeptical that the economy will see such impressive growth and most economists predict growth of a far more pedestrian 2.5% rate.
Also, investors need to ask themselves how much of the recent improvement in economic conditions is organic and how much is because of government stimulus spending. The federal balance sheet has ballooned over the last year as Washington has bailed out everyone from auto makers to mortgage agencies such as Freddie and Fannie and injected massive amounts of cash into financial companies that were on the verge of collapse. Since hitting its low in March, the stock market has largely reacted positively to this massive intervention. However, now the government is beginning to lay the ground-work to reverse some of its unprecedented intrusion into the financial markets and the newly-stabilized economy will soon have to grow without the crutch of federal assistance.
