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Has
Fear Blinded Us To Reason? (Answer: Yes) |
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We've talked
about it before, but it apparently bears repeating now - the market is
a voting machine, and not a valuation machine (ok, Benjamin Graham said
that). It's appropriately valued about 5% of the time, and errantly
valued the other 95% of the time. The bulk of investment gains are made,
however, in accurately spotting which is which, and when that tide turning.
The votes since
April 23rd have clearly been bearish. The S&P 500 has fallen more than
14% since then, and today's wasn't much help. The question from here, however,
is simple.... are current stock prices appropriate as they are 5% of
the time, or is this pullback part of the 95% of the time where fear or
greed have temporarily replaced logic and reason?
We'll take an
eye-opening look at the idea below; you may be surprised at the reality.
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Making
a Mountain Out of a Molehill |
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If
the section title (Making a Mountain Out of a Molehill) rings a
bell, it's because we used the same title
back on April 8th. Of course, we used it for the exact opposite
reason. That full title at the time was 'Making a Bullish Mountain Out
of a Molehill', and the message at the time was simple.... valuations
had gotten way ahead of themselves. Sure enough, two weeks later -
on April 23rd - the market began to unravel. [You're welcome, by the
way.] And, it hasn't stopped unraveling yet.
In the exact
same way stocks were able to over-inflate prior to April 23rd, may we
respectfully submit the possibility that the market is equally able to
over-deflate, as it has since April 23rd? Don't rule the idea out....
the 'overvalued' possibility was just as implausible and unpopular back
on April 8th, yet it turned out to be right.
 As
it stands right now, with the S&P 500's last trade at 1027.37, the
trailing twelve month P/E ratio (operating) stands at 15.5. The forward-looking
(Q2-2010 through Q1-2011) P/E ratio is a mere 12.2. Even when you calculate
the less-generous GAAP P/E ratio, the numbers are a paltry 16.5 and 14.5,
respectively.
Students of
historical market valuations will quickly recognize those are P/E ratios
not seen since 2006. There's a difference between now and then, however.
Earnings are on the way up now, but were on the way down
then. That's a major detail though.
Before then,
the last time we saw valuations tat low was in the mid-90's.
Point being,
like it or not (and thanks to the 16% pullback since April 23rd),
stocks are just dirt cheap right now in relation to long-term valuations.
How'd this
happen? .
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The
Bet They're Really Making |
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While most investors
may not know the P/E numbers above, these investors all well aware
of the reasons for the selloff. Take your pick of...
-
 BP's
disastrous oil spill destroying the Gulf of Mexico
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Greece's likely
insolvency Spain and Portugal's debt crisis
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The plunge in new
and existing homes sales
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Lingering high
unemployment
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The de-pegging
of the yuan
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The drastic dip
in consumer confidence
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China's growth
is slowing down (according to Aprils' data)
And that's just
the short list. If you dig deep enough, you can find even more
excuses to sell stocks.
Here's the $64,000
question though.... are any of those problems really going to hurt
earnings, at least in the way the recent correction suggests they will?
The knee-jerk is answer is 'of course'. Take a closer look
though.
Greece's economy
is half the size of Connecticut's. Its government could go bankrupt, and
(no offense) it wouldn't even be a blip for the global economy. No job
growth? Granted, but economic recovery has rematerialized in the U.S.
- as have corporate earnings - since Q1 of last year, without any
meaningful improvement on the jobs front. Indeed, personal consumption
(spending) increased
in May following April's dip. In fact, it's gone up in six of the
last seven months. Spain's mega-bank Banco Santander is off of life
support, and now successfully dealing with its loan issues. China's inflation
of the yuan may make their goods expensive to U.S. consumers, but it will
give the Chinese more power to buy goods from the U.S. or whoever.
The point is,
the assumptions that have been drawn from these fiascos aren't necessarily
the right ones. More specifically, the bet that all these sellers
are making right now is that one or several of these problems will severely
hurt earnings in the near and/or distant future. Ask any of these sellers
"specifically
why?" though. You won't get much of an answer.
Oh, it
would be crazy to think they'll be completely irrelevant issues
when it comes time to tally Q2's and Q3's bottom lines - all of these problems
can either cost money, crimp consumption, or both. But are they problems
to the extent that merits a 16% selloff and a 28% dip in 2010's projected
P/E ratios? Hardly. Fear and hysteria took over though, and a 16% correction
is what we got all the same.
To be clear,
though we're far more optimistic than the average right now, our bullishness
is not to say that stocks will undoubtedly go up from here - it's only
to say that they should go up from here. The market shouldn't
have soared in March and early April either though, yet it did. Likewise,
stocks may well continue their romp lower, deserved or not.
 The
conundrum is nothing new. In fact, it's the one consistently-reliable
thing the market can offer.... the tug-of-war between the short
run and the long run.
In the long
run, we have to feel that the expected earnings through 2011 will be pretty
much realized as expected. The short run can make you seasick though, especially
if you're hanging on to (and responding to) the media's every word.
So, your next
step is quite simple. If you feel all the reasons for the recent bout
of selling are hyped up way too much, and that earnings aren't in the serious
jeopardy they're alleged to be in - and there's no empirical evidence
yet to suggest they are - then this dip is actually a buying opportunity.
Or,
if you're already 'all in' for the long haul, then you can simply keep
holding, ignoring the noise that will largely be forgotten in a few weeks.
(Sorry, but that's the reality of it.)
Between
now and then, we'll continue to search for signs of a mini-capitulation,
so that we may time any new long entries just right. We'll let you know
when/if we see a day's action that's a capitulation candidate. Ironically,
Thursday's action and hammer-shaped bars may end up being it. We'll hold
out for a couple more clues though.
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Updated: 8:15 pm PDT (03:15 GMT), November 2, 2010
