The price-to-peak earnings multiple declined slightly to 11.9x as of last week’s close. On Friday, the market recovered from deep losses with a late-day rally that brought the DJIA back over the 10,000 threshold. For the week, the broad market indices fell between .5% and 1% with the S&P 500 now about 7.5% below its recent high.
In general, earnings reports have come in better than expected, but this has failed to boost market valuations. Companies are beating analysts’ EPS estimates about three-quarters of the time, but top line growth has proven to be more elusive. The bull market began about 11 months ago, and a large amount of the earnings improvement has been priced in to stocks. Under normal conditions, we consider a price-to-peak earnings multiple under 12x to be a bullish signal; however, this time, the reality is that earnings–while much improved over the past year–are still down 60% from their peak. Thus, we remain cautious regarding the market’s valuation even as fundamentals improve.
The percentage of NYSE stocks selling above their 30-week moving average has fallen for the fourth straight week to 51%. Investor sentiment has normalized after months of extremely bullish readings. A degree of uncertainty has crept back into the market as investors fear more sovereign debt problems out of highly-leveraged European governments. This has strengthened the dollar, but augers that the global economic recovery will be strained. On Friday, Moody’s warned of a possible downgrade of the U.S. debt rating unless spending is restrained. Economists have warned that soaring spending on entitlement programs will eventually become a problem, but according to Moody’s, this issue cannot be ignored much longer. Public debt issues at home and abroad, along with a persistently weak labor market have stock investors in the mood to take profits.
We remain defensive towards the market as sentiment has quickly retreated, reflecting growing worry and a refocus on risk. For the majority of the last year, the market rallied on the belief that, although fundamentals were not particularly strong, better days were surely ahead. However, a weak employment market underlies a potentially slow and grinding recovery rather than the typical post-recession rebound. In addition, the government is planning to exit from many of the programs that have propped up the economy. With the economy needing to stand on its own two feet, 2010 could be a much less favorable year for equity investors.
