9 ½ Weeks

For the bulls these past 9 ½ weeks were like the movie of same name – hot. However, the bulls (including many recent converts, especially from the land of momentum lemmings – the hedge fund world) should not forget that in the movie the lovers (Basinger and Rourke), drawn by the heat of the moment, have something as substantive and sustainable as a chimera. In a case where life imitates art, such may also be the story line with stocks.

Using the historical average P/E of 15 times and an optimistic $60 operating earnings number for the S&P 500 for 2009, stocks are projecting a robust earnings rebound into 2010 - a point made by my “Beyond the Sound Bite” guest from last week, Subodh Kumar, with a $75 call for next year. Only if that occurs AND/OR only if one accepts the talk I hear from some institutional investor circles that a P/E above its historical average is fitting for the times courtesy a low inflation rate (18 times is the number I hear), can an investor find fundamental support for the fragile technical analysis base stocks have built. However, it does give one pause when the leadership for this market is the same leadership that existed before the great tumble. Generally that is not how new bull markets get started and sustained, as the more common occurrence is for new leadership to take the helm. Rather, bear market parades are led by those who led before.

Investment Strategy Implications

9 ½ weeks ago I argued that stocks were grossly undervalued. Now, 9 ½ weeks later stocks, while not grossly overvalued, are more than fully valued. Built on the sand of a fragile technical analysis bottom led by those who led before make it more than justifiable to take some money off the table – most conservatively done by maintaining whatever the current equity percent of one's total investible assets at the current level, which in accounts that I manage is in the low 90% range.

In many respects the movie 9 ½ weeks was a study in extreme behavior devoid of real meaning and lasting substance. So, it is interesting to note that the stock market movie of these past 9 ½ weeks has brought out these qualities of extremes, including the expectations of more than a few investors with calls for more upside surges or great plunges. Therefore, allow me to offer an alternative view to this edgy thinking with a reference to another character from Tinseltown – George Costanza. Perhaps what investors will get in the coming months is a stock market movie not about heat but about nothing. A drifting, sideways, mini range-bound market where selectivity matters more than trend following, lemming-like momentum investing as investors digest what has occurred and guesstimate what 2010 has to offer and the appropriate P/E.

In such an environment, you can keep your (slightly bearish) hat on.