The price-to-peak earnings multiple ticked upwards to 13.0x as of Friday’s close. Equities broadly gained the first four days of the week before a slight sell-off in Friday’s action, but on the whole, developments were positive. Earnings continued to come in stronger than expected and a number of companies announced dividend increases, most notably PepsiCo (PEP). Consumer and producer price indexes showed that the threat of inflation remains subdued for the time being, and last week, The Federal Reserve restated its intent to leave rates extremely low for a while longer. While the market sees this as a good thing in the near term, the long term danger of a bubble fueled by easy money should be fresh in investor’s minds. Also, lest we forget, the Fed has left rates low as a stimulus for a still struggling economy, and their reluctance to raise rates should give some indication of their view of the recovery as still very fragile.
As far as valuation is concerned, the price-to-peak earnings multiple is not signaling an extremely overvalued condition, but it is now at the highest level in 19-months. Earnings have certainly normalized on a trailing twelve month basis, but the market is counting on significant further strengthening over the coming quarters. We continue to believe that the recovery will continue to grind forward, but the pace of the recovery may be slower than the market has already priced in.
The percentage of NYSE stocks trading above their 30-week moving average has fallen slightly to about 77% over the last week. Investor sentiment remains elevated this week, and it is easy to see why with new yearly highs on a 52-week basis outpacing new lows by a measure of nearly 54:1 (862 to 16). In our view, sentiment remains in the driver’s seat of this market, as investors continue to relish the better than expected earnings and general positive macroeconomic releases.
Health-care reform was finally pushed through in a Congressional vote on Sunday night, and the legislation will certainly have a major effect on the market going forward (more on this later). Now with the bill passed, do not expect the debate to cool very much as
multiple further votes will be required to pass adjustments and amendments to the bill’s language over the coming months. At the very least the passage of the bill ensures that the status quo will be replaced, and we will be interested to see the market’s reaction as uncertainty is generally met with resistance.
Our view of the market remains roughly unchanged, the trend is upwards but we would resist the temptation to deploy new resources into the market right now. Rather, we think the current environment (overbought sentiment, valuations not especially compelling, combined with rising political uncertainty) favors reducing exposure to risk. No one knows the way that the healthcare bill will affect corporate profits, but at this point the largest HMO providers are even to slightly higher on Monday morning. This shows the market believes the largest insurers will in fact benefit from the proposals, thanks to their ability to lobby and an estimated 30 million plus Americans who are estimated to be covered under the new bill.
As for non-healthcare companies, the outlooks is less rosy. Heavy-equipment maker Caterpillar (CAT) recently wrote a letter to Speaker Nancy Pelosi saying that the bill will adversely affect profits. To quote i On the Market, the free weekly email newsletter from iStockAnalyst.com,
“As for corporations and their profits, if Caterpillar’s (CAT) letter to Speaker Pelosi is any indication, profits and unemployment could join the opposite direction list.
According to Gregory Folley, vice president and chief human resources officer of Caterpillar, the bill “would increase CAT’s insurance costs by at least 20 percent, or more than $100 million, just in the first year of the health-care overhaul program.”
(We searched diligently and Caterpillar was the only major publicly traded company we found making such claims. We couldn’t find any that said it would save money and increase profits.)
If Mr. Folley and CAT’s calculations are correct, that $100 million a year will have to come from somewhere. It will come out of profits and from cutting costs, which probably means fewer employees and lower earnings per share for Caterpillar.” — iStockAnalyst.com