The price-to-peak earnings multiple advanced to 13.6x as of Friday’s close; the highest we have seen since September of 2008. US stocks gained strength last week on the back of impressive earnings. To date, trailing twelve month reported earnings have rebounded 89% from this time last year. Furthermore, more than 70% of companies have reported earnings exceeding Wall Street’s best estimates. Corporate earnings leave little room for doubt that most US companies are returning to health. We hope that other parts of the overall economy start to display a similar rebound soon.
While we accept that the US economy is improving, we do not believe that this is an opportune time to deploy new capital into stocks. As mentioned earlier, the price-to-peak earnings multiple stands at a 19-month high thanks to the S&P 500’s more than 83% rebound from its bottom. Earnings growth has greatly improved; however, we have begun to see signs of overvaluation. Some very strong, estimate-beating results have been unable to push certain stocks further upward this quarter, a trend that suggests that the earnings improvements were fully priced-in to the stock. Corporate insiders, while sounding upbeat on conference calls, are not buying their own stocks. This is often a sign that these savvy investors do not see value at current price levels.
US stocks are in an uptrend, but we urge investors to remain cautious. Equities are overdue for a correction, and we see many headwinds which could derail the uptrend. At times like these, complacency can be an investor’s worst enemy.
The percentage of NYSE stocks selling above their 30-week moving average is 83% as of last week. When investor sentiment reaches such extremely high levels, we see this as a sign of an overbought market. Stocks have benefitted from having a lack of attractive alternatives, as well as massive government stimuli over the last two years. Individuals and institutions have plowed money into stocks, almost begrudgingly at times, for fear of missing out on the run-up. So far that strategy has worked quite well, but we would be very cautious given all the unique circumstances (such as heavy government intervention and indebtedness) that undergird this
economy.
The financial crisis is now in the past by more than a year, and we expect that Washington will feel pressure to further retreat from its easy money stance going forward. Fed language has already begun to soften to the idea of rate hikes. We believe that inflation may soon become a problem and that potentially onerous financial reform legislation is imminent. Any rise in interest rates or evidence that the government is reigning in some of its largesse would likely diminish the appeal of equities—particularly at these lofty valuations.
If there is one takeaway from this week’s newsletter, I hope it would be to avoid complacency as an investor. The market’s steady rise has lulled some into a stupor. Continually questioning the market is a much better tact in our view, as one should be able to defend one’s selected exposure to stocks at any given point in time.
We continue to recommend modest exposure to stocks, but we reaffirm an equity allocation target of slightly less than your normal risk profile. There is no doubt that there are some stocks which remain attractive, yet overall equities are clearly overbought.
