The price to peak earnings multiple advanced to 12.3x as of Friday’s close. The stock market rallied two and a quarter percent in the last week, and this brought the price to peak multiple to its highest level in more than a year. The current market appears to us to be slightly overvalued, but the ongoing devaluation of the dollar is fueling the rally. Analysis varies widely on the where the dollar goes from here; we think it likely that the current devaluation will continue for quite some time. There is no doubt that the market has traded higher thanks in part to this trend and it may continue for some time.
From a valuation perspective, we think investors would be wise to continue to reduce risk in their portfolio. The market has advanced very strongly and is up 25% over the past twelve months. As we near the end of the year, it would not be surprising to see some year end selling to lock in gains. More importantly, we still see challenges ahead particularly as it relates to consumer spending. Most recoveries rely on increased debt-financed purchasing from consumers who believe better times are ahead. However, we see consumer debt continuing to shrink each month, and credit card issuers are overwhelmingly hiking interest rates even for those borrowers who continue to pay on time and in full. Combine these actions—which we consider unfriendly to consumers–with still growing unemployment figures and it is no surprise that consumer-related revenue remains sluggish. When the consumer makes up the majority of economic activity–as it does in the U.S.–we think the situation calls for caution rather than exuberance.
The percentage of NYSE stocks selling above their 30-week moving average has declined slightly to just under 82%. This investors sentiment metric has begun to subside from the highs of the last few weeks that were at extremes rarely seen. It appears to us that the average investor has a fairly high appetite for risk, but that may be starting to fizzle. The AAII poll of investor sentiment shows an even split among individual investors with 38.6% bullish and 38.6% bearish.
Financial stocks, many of which we would consider risky, have seen the market’s rally move away from them recently.
Over the past month, the high flying financial sector has actually lost about 2% while the S&P 500 index has gained about 2%. While this is too short a time frame to show an established trend, but considering financial stocks have led the direction of the broader market for more than a year now, we think it worth monitoring.
We continue to believe that despite the fabulous performance of the stock market recently, this is a riskier time than most investors wish to recognize. We are not market timers, and we have never met anyone that can time the market with consistent accuracy. That being the case, we like to evaluate the market’s risk to reward profile, and never take a risk that cannot be justified by a reasonably expected reward. That is why as the market continues higher we think it is appropriate to cycle allocation from risky stocks towards those that offer a higher margin of safety.
One of our favorite market analysts is Gluskin Sheff’s Chief Economist & Strategist David Rosenberg. He, like us, is concerned that the U.S. stock market is overheated and could be due for a correction. In his daily research note he made the following point.
“As an aside, S&P 500 operating earnings are coming in north for $15 for Q3, a quarter in which GDP growth came in at a 3.5% annual rate. Few believe we will sustain that growth rate but think about it for a second, the best we could do with 3.5% growth was an annualized earnings figure of $60 for operating EPS. So where does this thought process come from that we are going to be seeing anything close to $80 of earnings for 2010 — what the equity market has de facto priced in — with a consensus view that we will only see 2.5% GDP growth for next year?” — Breakfast with Dave: David Rosenberg 11/16/2009 (link requires a free login)
