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Courtesy of David Brown, Chief Market Strategist, Sabrient
You never actually know when it’s time to start buying stocks after a market drop, but let me give you a few “quantitative” hints.
The average forward P/E ratio for Sabrient’s top-ranked 100 stocks is normally between 7.5 and 8. At the 2011 market top on May 2, the average forward P/E for those stocks was 8.7. After today’s close, the average forward P/E is about 6.3.
Looking at it a different way, the market is down 22.5% from the May 2nd high through today’s close, but earnings forecasts have increased for the top-ranked 100 stocks. That makes the discount of the forward P/E nearly 30% lower than it was at the market top.
Let me pass along another interesting statistic. Sabrient produces an indicator that shows us how much we have to pay for the expected absolute quarter-over-quarter earnings for each stock. That number has nearly doubled since May for the top-ranked 100 companies. In other words, how much growth can I get for a buck? Almost get twice as much as I could get on May 2.
We’re talking undervalued versus overvalued. In May, when the average forward P/E was 8.7, we were quite choosey with our stock picks because the whole market was a tad pricey. Today, the S&P 500 Index is not that far from the February 2009 bottoms when the average forward P/E of our 100 top-ranked stocks was slightly over 5. In that issue, we called it an “historic buying opportunity” — which it was.
Clearly, the current market could drop yet another 20% before it reaches support. So we’re not yet at an historic buying opportunity, but perhaps it’s time to start nibbling. (See stock ideas below).
Hedging your bets. You could also hedge against volatility with the VXX, the S&P 500 VIX Short-Term Futures ETN which measures volatility in the market. (It’s also called the “fear index.”) The VXX has risen dramatically in the past two weeks, but it’s far from historic highs. In February 2009, at the market bottom, VXX had had reached a high of 450. By April 2010 it had fallen to 75. Within a month it climbed back to 145, then slowly drifted all the way to 20 in July 2011.
Today,…
