The price-to-peak earnings multiple held steady at 12.4x in the last week, and has been relatively unchanged for about six weeks. At this level it is hard to argue that stocks are overvalued based on peak earnings; however, reported earnings are still nowhere near the peak levels reported in the twelve months leading into the summer of 2007. Using the price-to-peak earnings valuation metric is most helpful if you believe that corporate earnings will return to the pre-credit crisis levels in short order, but we believe this is a risky assumption.
An interesting note was published on Barry Ritholtz’s blog last week that compares some top Wall Street strategists predictions for earnings in 2010. What is striking about the outlook from twelve of the top strategists is they are quite similar, as all are predicting a sharp rise in corporate earnings. 2010 per share earnings estimates for the S&P 500 range from $66 to $80, which is substantially improved from earnings in 2009 (likely to come in around $20 per share).
The percentage of NYSE stocks trading above their 30-week moving average is 82% as of the close of trading last week. This is still a relatively high reading for this investor sentiment indicator and implies that many investors maintain a hearty appetite for risk. Last week’s Investors Intelligence survey of money managers and newsletter editors found the third lowest percentage (17.6%) of bearish advisors in twenty two years! In general, when one sees sentiment skewed to the extremes of either bullishness or bearishness, it is a contrary indicator. According to Jason Goepfert of SentimenTrader, the ten past ten lowest readings on bearishness have been followed—on average—by a loss of 1.6% in the following month.
At Ockham, we continue to see this market as overbought with relatively unattractive valuations (unless you believe peak corporate earnings levels will soon return). Long term investors must consider the fact that, nine months into this rally, a lot of economic improvement has already been priced into the market . We are not predicting an impending market swoon but there are legitimate reasons to be wary…
Credit delinquencies continue to rise and unemployment continues to swell. At the same time financial firms are rushing to pay off TARP loans in time to pay out year end bonuses. Most are issuing new stock to raise money to pay off these loans and these capital raises are diluting shareholders in the process. While the ability to readily raise large sums of cash in the secondary market is a bullish sign, it does leave these still-wounded financial firms more vulnerable to future problems should the economy turn south again. In closing, a note from John Hussman demonstrates why the risk/reward proposition in this market looks unappealing.
“…Again, we don’t have to deal with and correct all of these problems, but until it is clear that the markets are more aware of them, the range of potential market outcomes will be extremely wide – and in my estimation, tilted toward the downside. As we learned from the various bubbles of the past decade, discounting a risk means more than simply paying lip service to it. Major risks are not discounted by talking about and dismissing them. Risks are discounted when it is taken for granted that they will get worse. Positives are discounted when it is taken for granted that conditions will continue to improve. From my vantage point, we are much closer to having fully discounted the positives than we are to even scratching the surface of the second wave of negatives.
From current valuations, durable market returns appear very unlikely. As I noted last week, whatever merit there might be in stocks is decidedly speculative. That doesn’t mean that the returns must be (or even over the very short term, are likely to be) negative. What it does mean is that whatever returns emerge are unlikely to be durably positive. Market gains from these levels will most probably be given back, possibly very abruptly.”
