 |
In
This Edition... |
|
It took a lot
of digging and even more number-crunching, but it was worth it.
Today, we've got some well-founded research about how stocks are likely
to respond to earnings results in 2010 and 2011.
While earnings
are indeed getting better (real earnings - not just the accounting kind),
fickle investors and slow earnings growth suggest stock prices aren't
going to be skyrocketing anytime soon. On the flipside, the gloom-and-doomers
have no reason to be smug either. We'll take a look at the market's good
and bad, and come up with a projected valuation below.
First though,
some highlights from the blog:
-
The
Rebound's Stealth Beneficiary.... It's So Obvious, It's Obscured -
There's nothing wrong with owning the mainstream ideas when it comes to
picking stocks. On the other hand, sometimes an industry can be
so old-school and/or so amorphous, that it's easy for everyone to overlook
it... translating into opportunity for those few who do manage to
identify the undervalued arena. Here's one of those groups.
-
Consumer
Confidence Blips - Take a Breath, & Think it Through - The
knee-jerk reaction isn't always the right one. In fact, when it comes to
sentiment data, a true knee-jerk reaction is usually the wrong one.
That's why we all need to take a breath and think things through before
reading too much into this week's consumer confidence data. Here's some
perspective.
-
Big
Military Budget Means Big Boon for Small Defense Contractors -
Who
says Democratic President Barack Obama intends to shrink the military?
The budget says quite the opposite. Here's a look at some of the unknown
stocks that may be the biggest beneficiaries of a still-swelling military
budget.
|
 |
A
Realistic Market Valuation Forecast.... Uh-Oh |
|
|
With
88% of the S&P 500's Q4-2009 earnings now in (and now that Standard
& Poor's has updated their marketwide outlooks through 2011), we've
got more than enough data to reassess where the market's likely
to be headed over the course of this year. Let's just say it's a mixed
bag.
Assuming the
S&P 500 were a company and not just an index, we can assign
it all sorts of company-like attributes. The two we're most interested
in are earnings per share (the index itself acts as one share),
and a P/E ratio. With just these two simple measures, we can actually do
quite
a bit in the way of assessing the market's health and making a reasonable
price forecast.
A couple of
housekeeping items first though, just to set the stage.....
The Good
 Earnings
are indeed getting better - this is undeniable. Now that nearly 90% of
the companies in the S&P 500 have reported earnings, we know that the
S&P 500 itself will 'earn' about $17.34 (operating) per share for Q4
of 2009. On a GAAP or reported basis, the S&P 500 will earn about $15.72
per share.
Just for perspective,
those figures were -$0.09 per share and -$23.15, respectively, in
the fourth quarter of 2008. Each has gotten sequentially bigger since then.
As of Wednesday's
closing price of 1105.24, the S&P 500's trailing-twelve month operating
P/E is 19.47, and its equivalent GAAP or reported P/E is 21.45. For comparison,
the long-term averages of those numbers are 19.40 and 26.18, respectively.
(Those averages are marked by red and green dashed lines, respectively,
on the accompanying charts.)
Better still,
both earnings figures are expected to at least hold flat or continue improving
this year and next. Standard & Poor's is looking for an operating EPS
of $21.26 in the fourth quarter of 2010 ($77.72 for the full year), and
a GAAP EPS of $14.48 in the fourth quarter of this year ($58.46 for the
full year). That translates into a 2010 P/E of 14.21 and 18.90, respectively.
So what's
the problem? Comparing the projected P/E ratios to the long-term average
P/E ratios says stocks are undervalued by anywhere from 19% to 27%. Based
on those numbers this is a no-brainer - get in the market and enjoy the
ride, right?
The problem
is timing. Keep reading.
The Bad
The funny thing
about 'averages' when it comes to the market... the data in question spends
much of the time above the average or below the average,
but very little time at the actual average itself. And yes, this
applies to the S&P 500's P/E ratios.
 The
reality is - and this is at the core of what could hold stocks back
in 2010/2011 - the P/E ratios in post recession environments like the
one we're in now tend to be at the very low end of the typical P/E range.
Historically speaking, P/E ratios tend to sink until we're about at the
midpoint of the market's post-recession growth phase. We saw this coming
out of the 2001 bear market as well as when we were coming out of
the 1990 bear market. (Click
here for that full-screen perspective.)
So what?
The 'so what' is that while stocks may be priced and/or headed to lower
than average prices relative to earnings, they may already be priced
appropriately at this point in the cycle.... which is the second year of
the recovery.
Said another
(more
direct) way, anyone assuming stocks will price themselves according
to the normal operating and GAAP P/E ratios of 19.4 and 26.18 by the end
of 2010 may be sorely disappointed. Stocks may already be at or
near their maximum valuation for this stage of the cycle.
Historical
Perspective
 To
add some detail to the warning, following the 2001 bear market, the S&P
500's operating P/E ratio didn't bottom at 15.55 until the middle of 2006...
more
than three years after the index itself had hit its ultimate bottom.Its
operating P/E ratio didn't bottom at 14.47 until late 1994 following the
1990 bear market... four years after the market began to move higher
again. (Click
here for the entire P/E ratio history for the S&P 500.)
Do you see
where this is going? If history is any indication, we should expect
operating P/E ratios to drift towards 15.0 in 2010 - not the normal
19-ish - as we enter only our second year of the recovery phase.
Based on that
P/E and the previously-discussed earnings forecast, it would be hard to
say the S&P 500 will be worth much more than 1165 by the end of the
year - about 5.5% higher than its current trading level. Applying the same
math on a GAAP/reported basis suggests the S&P 500 will actually be
worth less by the end of 2010 than it is now.
None of this
is intended to frighten you. In fact, you shouldn't be frightened at all
- the market is recovering. Moreover, the forecast can be adjusted
between then and now (though they're rarely significant adjustments).
Our only intent
is to encourage investors to recognize that what the market considers
to be an appropriate price is always changing. Here in an environment
where investors are still a little shocked and worried, it's much tougher
for stocks to justify frothy valuations. Indeed, history says they won't...
at least not for a while.
Bottom Line
In simplest
terms, these numbers are a recipe for mediocrity (at best) for 2010,
and perhaps beyond. That's not inherently troubling unless you're a true
buy and hold investor. See, the odds are very much against a broad
market tide rising and lifting all boats with it in 2010. History tells
us so.
The secret to
sustaining 2009's progress into this year is focusing on the best of the
best sector, industry, and stock trends, and being pro-active with them.
Yes it's a little more work, but it beats a wasted year.
|
Updated: 8:15 pm PDT (03:15 GMT), November 2, 2010
