The price-to-peak earnings multiple dropped to 11.7x as of Friday’s close. The market dropped 2.2% last week with macroeconomic data weaker than expected. Bad news regarding existing home sales and durable goods orders brought stocks down as many investors seized the opportunity to lock in profits. A correction after such a strong rally would not be unexpected, and thus far in the 29-week long rally, there has only been one incidence of consecutive weekly losses. Interestingly, that four-week losing streak happened in late June/early July in the run-up to second quarter earnings. We are currently in the same type of period, as third quarter earnings season will not be in full swing until the second week of October.
During the weeks of relative quiet on the corporate earnings front, the market constantly reevaluates whether stocks justify present valuations. Our opinion is that the market is neither greatly overvalued nor undervalued at current levels. We do think that the market is pricing in a substantial amount of earnings improvement and is heavily overbought at the moment. Historically, when the market has had a tremendous bull run and expectations for the future are still sky high, we tend to become more cautious as this is not the optimal market environment for buying.
The percentage of NYSE stocks selling above their 30-week moving average remains elevated at 90.7%. Our proxy for general investor sentiment is still showing a hugely bullish trend, although we are now 29-weeks past the market’s bottom, so most stock’s 30-week MA’s will start to normalize soon. This should begin to moderate this sentiment metric, but it will likely remain firmly on the bullish side for some time.
Looking back at the above-referenced four weeks of S&P 500 declines, notice that sentiment turned down without a steady stream of earnings reports to fuel the rally. While earnings remain weak, they are better than analyst expectations and this upside surprise has been the biggest driver of the rally. Analysts have been increasing estimates for most companies over the past six months and equities have priced in this improvement in outlook. We will be interested to see over the next week and a half if the market will behave similarly to the last lull in earnings results.
To further expand on the theme of earnings driving the market higher, we turn to the Wall Street Journal’s E. S. Browning who writes about the trend of companies outperforming Wall Street’s expectations. In his article, he sights one bear who has now capitulated and expects the market to return another 15% gain through the end of the year. Talk about an indication that market psychology has become extremely bullish!
“Earnings in the first two quarters of the year that beat expectations helped propel the market’s recovery, and the prospect of a repeat has even some bears wondering if they have been too pessimistic.
Morgan Stanley investment strategist Jason Todd, one of the few remaining bears on Wall Street, told clients last week that the stock market is looking stronger than he thought and won’t tumble, as he has been predicting, at least through the end of the year. “We think equities will now trade above” his previous target for this year, Mr. Todd said in his report, “in large part because earnings will be higher than we previously anticipated.”
Until now, Mr. Todd had been predicting the market would fall 14% from today’s level by the end of the year. Now he is telling clients that the Standard & Poor’s 500-stock index — which is up 54% from its March 9 low — is likely to rise marginally between now and year’s end and could be up as much as 15% before it gets into trouble.” E.S. Browning in The Wall Street Journal
