The price-to-peak earnings multiple held steady at 13.4x as of last week’s close. Earnings season rumbled forward with impressive results from major market bellwethers such as Bank of America (BAC), Intel (INTC), JP Morgan (JPM) and United Postal Service (UPS) among others. All Wall Street analysts have forecast vast improvements over the very weak quarter a year ago, but the early results have easily topped expectations. Companies are benefiting from leaner cost structures as many drastically reduced headcount and various other costs such as inventory in order to lessen the blow of slowing economic activity during the recession. This trend is evidenced by data collected by First Trust Advisors that, on average, companies have grown revenue 10% from this period a year ago, with a 40% growth in profits!
The stock market has thus far handled the high expectations quite well, but some individual stocks have fared poorly. For instance, Internet search giant Google (GOOG) reported earnings and revenue that exceeded expectations, but its stock fell nearly 8% the day after the results were released for failing to top the “earnings whispers.” When earnings expectations and investor sentiment are at extremely lofty levels, sometimes even solid results are met with disappointment. To us, this serves as further evidence that much of the real improvements we are seeing in the economy have been priced-in during this 13 1/2 month bull market.
The percentage of NYSE stocks trading above their 30-week moving average crept ever higher to 81% as of the close of trading on Friday. This indicator of investor sentiment would surely have been even higher had the market not sold-off on Friday due in large part to charges brought by the SEC against Goldman Sachs (GS) for its handling of the sale of certain mortgage backed securities. We continue to believe that investor sentiment remains at extremely and even potentially dangerously high levels. For example, AAII’s survey of individual investors shows that 48.5% of those surveyed are bullish as of this week, which jumped 5.6% in the past week and 16 points in the past three weeks to stand at its most bullish level thus far in 2010. The bullishness of individual investors currently stands well above the long term average of 39%.
When investors start to take on a herd mentality, it has historically been wise to consciously remove yourself from the “group think”. Whether the Goldman Sachs lawsuit is the sort of catalyst to break down the bullishness of investors is highly debatable, as the market has shown an amazing ability to shake off potentially distressing news. However, we think the timing of the suit is at the very least suspect, as it was filed within days of a major vote in Congress over financial regulatory reform. Could the alleged double dealing of Goldman Sachs be enough to sway a few of the legislators who were previously on the fence about the proposed reforms?
The Goldman Sachs suit and impending reforms could provide a cloud over the otherwise sunny earnings season in the US stock market that may rival the literal cloud of ash sitting over Europe right now. At Ockham, we maintain our long term view of the market that suggests valuations are not particularly attractive and sentiment has climbed to an unsustainable level. In such a situation, we recommend that investors focus on reducing the risk in their portfolios to shield themselves from potential losses. Of course we believe that there are undervalued stocks in nearly every market condition, but today those stocks with appealing value are increasingly difficult to find. At Ockham, we continue to advocate investors stay in the market, although our asset allocation model has ratcheted down on the optimal equity allocation as of this week. We recommend that long term value minded investors hold only 75% of their normal allocation to equities given the prevailing market environment. We see stocks as overbought and the current valuations are not attractive given the rapid appreciation in the recent bull market.
