The price-to-peak earnings multiple held steady last week at 12.4x as major equity indexes were little changed. As in the recent past, earnings have come in well ahead of expectations thus far ; although, they still have a long way to go before reaching optimistic, full-year estimates. At present levels, valuation is not a major concern so long as earnings steadily improve; however, we believe that a substantial amount of earnings growth has been priced into stocks at current levels.
Trailing twelve month reported earnings for the S&P 500 stands at $41.12, which represents a quick rebound from its multi-cycle low of $9.96 at the end of October last year. This earnings recovery comes from two sources; first, far fewer asset write-downs have been reported, and second, a solid rebound in corporate profits largely due to reduced expenses. Week-by-week, fewer write-downs are being factored into the earnings picture and we will be very interested in seeing just how much organic growth is manifest in this economy.
The percentage of NYSE stocks selling above their 30-week moving average slipped a bit to 66% as of last week’s close. In the current market environment, sentiment seems to be more troubling than overall market valuation. As is clearly demonstrated by our chart showing one measure of sentiment, over the past year or more we have seen extremely high levels of both bearish and bullish sentiment. Just in the last week we observed a number of decidedly bearish indicators (Latest Data Shows Sentiment is Firmly Bearish) related to various important sectors of the US economy. In addition, sovereign debt in Europe continues to represent a huge uncertainty weighing on the market with Greece on the brink of default and, perhaps more importantly, Spain close behind.
Whether or not investor sentiment is simply moderating from extreme bullishness or may again swing to the downside is unclear. We think a moderation would be a healthy and natural development considering where we have been for the better part of the year. In our opinion, sentiment rather than fundamentals, has been the driving force behind the market’s recent bullish performance. Thus, sentiment should be closely watched in the weeks ahead.
Last week, an upward revision of Q4 GDP to 5.9% barely moved the needle for the equity markets. Of course, the stock market is forward-looking and thus investors will likely be more sensitive to this week’s data on ISM manufacturing and employment, especially with earnings season winding down. For ISM, anything above 50 was considered an improvement, but economists on average expected something closer to 57.5. The result, released Monday morning, was just shy of projections but did show relatively strong growth compared to the dismal manufacturing numbers from February 2009. Improvement in the labor market has proven to be more elusive and we expect the unemployment rate to remain at 9.7% or possibly worse.
On the whole, we continue to advise long-term, value investors to be cautious about deploying additional resources into this market. Overall market valuation is not particularly attractive and investor sentiment seems to us to be swinging to the bears side. With that said, this is an optimal environment for owning high-quality, defensive stocks rather than the riskier securities that have been bid up in the last year as sentiment was riding high.
