The price-to-peak earnings multiple fell to 12.6x after the S&P 500 declined by 4.9% last week. European debt fears created market tension and then on Thursday what appears to have been a technical glitch sparked a massive sell off in US equities. In a matter of minutes the Dow went from down 300 pts to nearly 1000 pts; if you blinked you could have missed it. For weeks, we have been skeptical of the current rally’s foundation, and we think the wave of selling late last week confirms some of those fears. The market saw the return of fear for the first time in a long time, and traders sold first and asked questions later.
Earning reports continue to come in better than expected, but earnings have taken a back seat to sovereign debt issues in the market’s psyche. After all, we believe the market has already priced in substantial improvement in earnings. So, to see earnings growth that outpaces Wall Street’s expectations is no longer enough to push the needle. Value investors must always be cautious of such a market condition, as we expect volatility to remain high going forward following some very quiet months.
The percentage of NYSE stocks trading above their 30-week moving average tumbled to about 49% as of Friday’s close. Our metric for measuring investor sentiment took a serious dive last week from extremely bullish levels. The prevailing attitude among investors seemed to be complacency, as the market was viewed by many as destined to continue higher indefinitely. That complacency was wrung out of the market in a matter of minutes, as Thursday felt more like the trading days shortly after the fall of Lehman than anything that we have seen in some time.
After the massive drop off in sentiment, this signal is no longer at distressingly bullish levels. However, we would advise investors to continue to tread lightly in this environment. Fear was evident in the market and we anticipate many investors will be content to take profits at this stage. The stock market hates uncertainty and with the deterioration in Europe investors must stay on guard.
On Monday equities surged thanks to The European Union’s commitment of €750B ($966B) in order to contain the public debt crisis. Investors are clearly putting a lot of faith in this plan to bail-out the Euro zone, but to us it demonstrates just how serious the situation has become. As part of the relief package, the European Central Bank will actually buy government bonds; a step it was strongly opposed to in the past. This was considered a “nuclear option” by some pundits, and at the very least it is something that the ECB was uneasy about up until very recently. We are concerned that this “solution” will only kick the can further down the road, and that the Euro and its member countries still have significant structural challenges. Of course, we would like to believe this measure is large enough to fix the sovereign debt crisis, but only time will tell.
