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Stocks
May Be Undervalued, But Is That Enough? |
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January
of 2009 may well have been the worst January in decades, with the S&P
500 falling 8.5%. But, the first week of February offset a big
chunk
of that loss. Last week, the S&P 500 gained 5.1%. Point being,
we're not quite in the dire straits much of the media would have
you believe.
 So
where exactly do we stand then?
In a nutshell,
we're
still on the verge. The bears are still very much alive and kicking,
but they don't have total control. After hitting bottom in November,
the bulls have given the bears a couple of black eyes, and have been
far more resilient than most thought they could be. Yet, the bulls
still haven't taken complete control yet. Thus, they're only "on
the verge".
To be specific,
the S&P 500 is - once again - toying with its 50 day moving
average line (purple).
Following November's
rebound, the market barely made it back above that moving average in December,
but then turned south again anyway. That was a small pullback though, and
less than two weeks later we were well above the 50 day average
... temporarily. That would be the last time we've actually seen
the key moving average line hurdled; we tried to move above it again in
late January, and we're trying to do so again right now.
So, that's
still our ultimate line in the sand ... the S&P 500's 50 day
moving average line at 869. The index closed at 868.30 on Friday after
peaking at 870.75. The 50 day line was precise resistance two weeks ago
as well, sending the market lower after a monster four-day rally that some
thought was the beginning of a major recovery.
Important near-term
milestones include 877, and then 918. If we can get past those levels,
the bulls should find life much easier. Stay tuned for updates of
this chart. In the meantime...
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What
About The Fundamentals? |
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The chart is
only half the story, right? Is the average stock also
fundamentally valued at a price that inspires buying rather than more
selling.
 As
of our last look, the S&P 500's price/earnings ratio for 2008 is estimated
to be 14.3. Not all fourth quarter earnings are in yet, so the number could
change a little over the next few weeks. But, it won't change significantly.
That P/E reading
is actually less than 2007's ratio of 17.8, and less than 2006's
P/E ratio of 16.2. Get this though ... 2009's projected P/E ratio
is a mere 12.0.
So why isn't
the market flying through the roof if stocks are so cheap? There are
a couple of possible reasons being posed by most investors. The first
one
is simply doubt about the projected numbers. Can earnings really be
better in 2009 than they were in 2008? The second reason is
that 2007's and 2006's numbers may have just been too high. Maybe a P/E
of 14.3 is the 'right' value.
We're not really
worrying about either of those theories right now though, since they may
be irrelevant given the current situation.
We'd be the
first to acknowledge a projected P/E of 12.0 may be a little lofty for
2009. However, we also think a P/E ratio of 14.3 is actually
pretty low (historically speaking). Moreover, we don't think
a price/earnings ratio in the 16 to 17 area is excessive. Translation:
Stocks may well be undervalued right now even if earnings projections
are overly-optimistic for the current year.
So what's
the 'magic' P/E number that's supposed to signal a bottom? There's
the rub - there isn't one. There's a zone or range typical
of market bottoms that hovers around the single-digit area, but each bear
market's uncle point is a little different, and should be taken on a case
by case basis. In 2008's case, we think a P/E level below 13.0 is sufficiently
low to prompt more people back into the market than are bailing out of
it.
If we were alone
in our opinion we might rethink it. However, there's an interesting argument
that suggests most investors also think the average stock is undervalued
right now - the S&P 500 has gained 15.5% over the last eleven weeks.
Cheap stocks
that are also rising? We're taking it at face value.
Yes,
there are many more landmines to navigate in 2009. Don't over-think this
though. A rising stock is a great investment, even if the company is flawed.
Conversely, a falling stock of a great company is still a falling stock.
The market may
still have flaws too, but the market is also predictive of future
values rather than reflective of current values. If stocks are rising,
they're probably doing so for a reason. In this case, it's probably because
they're historically cheap, and are offering more reward than risk.
Will they
keep rising? Maybe. We know that cheap stocks are more likely to rally
than expensive stocks. But, the 50 day moving average line will tell us
whether the current rally is for real, or just a fake-out. That's why we're
watching it so closely.
 Bottom
line - Between the chart and valuations, we see more upside than downside.
Keep 'em all on a short leash though.
Note: Most
investors tend to favor fundamental analysis as a method for picking stocks
or deciding to be in or out of the market. On the other hand, some investors
- mostly traders - utilize technical charts to make buy/sell decisions.
Very few investors utilize both techniques though.
We utilize
both approaches, recognizing that timing our entries and exits is half
the battle. The other half of the battle is finding stocks that are valued
low enough to attract other investors in the future. In other words, both
technical analysis and fundamental analysis help us to buy low and sell
high.
Strictly
using just one approach or the other can put an investor at a serious disadvantage,
as each technique has inherent flaws. Combining the two approaches can
cancel out a great deal of those flaws, and provide a framework that's
designed to make money rather than just apply theory. That's why we'll
continue to discuss charts as well as fundamentals.
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What
You Missed in the Blog |
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It's been a
busy week for the blog. If you're not visiting it on a regular basis, you're
missing some great comments and ideas. Here are a couple of hihglights
from last week:
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Updated: 8:15 pm PDT (03:15 GMT), November 2, 2010
