The overwhelming consent is certainly that the worst is over. Early in January, optimism had reached levels not seen in years, even decades. How can optimism be measured?
Investors Intelligence tracks the recommendation of different market advisors. In early January, 53.4% of all advisors were bullish. 30.7% of advisors were longer term bullish, but believe a short-term correction is likely. All together, 84.1% of advisors expected higher prices. Even the October 2007 market highs did not elicit such a positive response.
How about retail investors? According to the American Association of Individual Investors (AAII), investors are only keeping 18% of their money in cash. This is the lowest level since April 2000.
It is important to connect the dots when talking about investor sentiment. The last extreme reading of market advisors occurred on October 15th, 2007, within less than a week of the all-time market top. Thereafter, the broad stock market fell (NYSEArca: VTI) 55%. Real Estate (NYSEArca: IYR) and financials led the charge lower.
The last time investors felt comfortable enough to keep only 18% of their money in safe cash was in the very early stages of the tech-crash. Within a year, the Technology Select Sector SPDRs (NYSEArca: XLK) and Nasdaq (Nasdaq: QQQQ) had lost more than half of their money.
No doubt, the optimism surrounding this year's earnings announcement (at least initially) was decisively bearish to the astute investor. In the past, when earnings season was greeted by extreme optimism, the S&P 500 was 2 - 3 times more likely to go down than up. The maximum performance to the downside trumped the upside by more than 2x.
Optimism means lower prices
On January 15, 2010, two trading days before the closing highs were reached, the ETF Profit Strategy Newsletter made the bold statement: “Bullish sentiment has reached a level where it is suffocating nearly all bearish currents and undertones. The natural reaction would be, and has been by most, to conform to the trend, join the crowded trade and turn bullish. Historically, such extreme optimism leads to market declines. Even though the up-trend has lasted longer than expected, we believe that every day that brings higher prices presents a better opportunity for the bears”
Slowly but surely, euphoria is starting to be replaced by skepticism. If major corporations make little or no profit, how do you put a price tag on their stock? Where is their fair value?
Are stocks cheap?
The Standard and Poor's P/E ratio for the S&P 500, based on actually reported earnings, is 84.30. This means it would take any S&P constituent an average of 84.3 years to repay the money it borrowed from investors. This does not include interest. How willing would you be to offer a business loan payable over 84.3 years at no interest?
Of course, the P/E ratio falls if you compare the current price with expected earnings. But as we've learned above, Wall Street has a tendency to go with the flow when it comes to earnings. The flow right now is not up.
In March, when things looked bad, Wall Street expected things to get worse. A few weeks ago, when things looked good (after a 70% rally), Wall Street expected things to get better. With earnings disappointing, but still expected to rise another 23%, analysts might once again be forced to revise their forecast – after the fact.
What’s next for stocks?
Different valuation metrics are the markets built in temperature gauge. When things heat up, the market is forced to cool down - this means lower prices.
Historically, the market is 'healthy' with a P/E ratio around 15. Based on actual earnings (P/E of 84.3) the market is overvalued by more than five times. Using a more 'conservative' methodology, the S&P 500 (NYSEArca: SPY) on a normalized Shiller P/E basis, is overvalued by close to 30%.
P/E ratios are not the only valuation metric, however. Dividend yields and the Dow measured in real money - gold (NYSEArca: GLD) are others.
All major market bottoms over the past 100 years had one thing in common;
- LOW P/E ratios and
- HIGH dividend yields.
A look at the Dow Jones measured in gold shows just how overvalued stocks denominated in U.S. dollars (aka Dow Jones) have become. Indicative of their implications, we've dubbed the composite indicators consisting of P/E ratios, dividend yields, the Gold-Dow, and mutual fund cash levels as the 'Four Horsemen.'
The ETF Profit Strategy Newsletter contains details of the 'Four Horsemen,' plotting stock market prices and each indicator individually against historic market bottoms, along with a short, mid and long-term forecast that includes the target range for the ultimate market bottom.
http://www.etfguide.com/research/260/8/Earnings-How-Will-They-Affect-The-Market?/
No comments:
Post a Comment