The price-to-peak earnings multiple dropped to 13.3x which was in-line with the market’s decline last week. A few stories dominated the headlines last week; chief among them, grim reports from the Gulf of Mexico regarding the Deepwater Horizon oil rig disaster which will require billions of dollars and a Herculean effort in order to try to contain massive ecological damage . Also, news of a potential criminal fraud investigation of Goldman Sachs triggered a sell-off in financials, which tainted the entire market. These two huge news stories overshadowed favorable news in what has continued to be a very strong earnings season.
Corporate earnings have rebounded nicely as companies are leaner and more productive than at any point in recent memory. Trailing twelve month reported earnings on the S&P 500 have rebounded 83% from this time last year to over $52. With consensus Wall Street estimates calling for 2011 S&P 500 earnings of about $95, earnings will need to grow by another 82% over the coming 19 months. Is that possible? Absolutely. However, when a market is already priced to deliver 80+% earnings growth, the likelihood of further market upside based on positive earnings news seems statistically unlikely. There is very little margin for error in the market’s current valuation.
The percentage of NYSE stock selling above their 30-week moving average dropped to 82% with last week’s close. Worries regarding the European sovereign debt crisis continued last week and, over the weekend, the EU bailed out Greece to the tune of $146 billion. Add in S&P debt rating downgrades for both Portugal and Spain and things are looking worrisome in the Eurozone. Not surprisingly, the market is reacting positively to news of the Greek bailout, which will be majority funded by EU member countries with the International Monetary Fund picking up the remainder. While stock investors may get some short-term solace from this bailout, the long-term picture for Europe remains extremely troublesome, witness the downgrades of Portugal and Spain’s debt ratings. Current civil unrest in Greece threatens any economic stability that the bailout might produce, and one has to wonder what nation will be willing (or able) to pay for any further bailouts in Europe.
Partly because of debt worries regarding the EU, investor sentiment has remained quite bullish for US equities. We have no doubt that turmoil in Europe make US stocks appear less risky than their European counterparts, but the return of downside volatility such as we saw on Friday could be just beginning should further sovereign debt crises arise. Also, look for continued strengthening of the dollar versus the Euro, which in the long run is a positive development as the dollar cements its standing as the globe’s safest currency. That being said, over the short term we may see an unwinding of the carry trade which would surely hamper a continuation of the rally.
For value investors with a long term focus our stance remains unchanged this week; valuations are not attractive and the market is clearly overbought. Investors should be looking for ways to lessen risk in their portfolio rather than taking on more. We have not seen even a moderate 10% correction since March of 2009 and we think a pullback such as this would be healthy for the stock market going forward.
Generally speaking , the macro economy has gotten healthier and corporate earnings have certainly come back to more normal levels. However, other sectors of the economy still hint at weakness with bank lending still restrained, foreclosures a persistent problem and the threat of rising interest rates to name a few. Also, after the expiration of the first time homebuyer’s tax credit, we are anxious to see what affect that will have on the still nascent housing stabilization.
