Minyanville article: Buyer Beware - The Bottom Is Not In Yet

"My article for Minyanville this week focuses on a subject that is very much a part of the investment equation for most investors - emotions. "Stocks are on a tear again today hitting new recovery highs, as passionately bearish investors just tear their hair out. And that emotional quality is the subject of this article.

In philosophy, “I think, therefore I am” is a truism. In investing, however, it seems that many investors subscribe to the variation, “I feel, therefore I invest." And therein lies the subjective rub that imposes the belief of what "should be" and alters the objective view of "what is."..."

To read the complete Minyanville article, click here
To view all Minayanville postings, click here

The Macro Economic Reports Indicator: Not A Good Omen

Since peaking on July 10, the Macro Economic Reports Indicator (first introduced on this blog on June 17) has stagnated. Including the two major macro economic reports issued thus far this week (consumer confidence and durable goods orders), the indicator now sits a full 3 points below its July 10 peak (see table*). This is not a good omen for future earnings expectations.

Investment Strategy Implications

With so much stock market value built into future earnings reports, below consensus readings in the macro economic sphere suggest a heightened risk factor to future earnings reports coming in above expectations – a necessary ingredient for higher equity prices.

As noted in yesterday’s blog posting, earnings need to be rather robust over the next six to twelve months to justify current equity valuation levels. When macro economic reports, especially the kind that were issued thus far this week, come in well below consensus expectations (not to mention the sizable downward revision in today’s durable goods orders), investors are advised to proceed cautiously.

*click image to enlarge

It Ain’t That Simple

15 times $70 = 1050
1050 minus 10% = 945

This is the fair value math for the S&P 500. An appropriate P/E times a believable operating earnings number (12 months forward – mid 2010) minus an appropriate discount rate (stocks are, after all, a discounting mechanism). Of course, one can debate the inputs and the appropriate discounting time period, but the methodology is flawless.

Embedded in the methodology are elements that should (but often don't) go beyond simple business cycle, industry, and company analysis. Factors such as:

• A new world economic order
• A new financial services business model
• The appropriate amount of government intervention

Factors that I will discuss at next Tuesday’s New York Society of Security Analysts “Market Forecast” luncheon.

Unfortunately, these macro factors are not part of most investors’ toolkits. Beyond how such macro factors will impact the shape of the business cycle, big think subjects (such as, What economic philosophy will be the guiding force now that laissez-faire/cowboy capitalism is no longer the dominant principle?) have no way of being incorporated in your standard research methodology. Beyond the subjective aspects of such information, it is difficult to impossible for many investors to fit a new world economic order, for example, into your standard discounted cash flow model. Put differently, there’s no CAPM for the obvious yet out of the box factors that move economies and markets. Yet, they do matter.

Investment Strategy Implications

By all accounts, stocks are more than fully valued. Only those with the rosiest of glasses can envision earnings and P/Es greater than those listed above. Then again, a return of animal spirits overriding the highly uncertain transitional macro elements noted above is not out of the question – especially with $3.5 trillion* still sitting in near zero percent money market funds.

*A hefty 41% of the market value of the S&P 500

Imagine This

The above consensus earnings results produced thus far – 109 companies in the S&P 500 (29% of market cap) 10.3% above estimates* – are doing their thing and moving the fence sitters off the fence. No doubt some of the $3.5 trillion sitting in near zero interest rate money market funds is finding its way into equities. In the process, an overbought stock market gets even more overbought – moving right into the S&P 500 resistance zone of 950 – 1000.

As investors reacquaint themselves with their animal spirits, let’s do something constructive and take a moment to assess the investment significance of the aforementioned 10.3% above estimates fact.

Coming into this week, 2Q09 operating earnings estimates for the S&P 500 were around $14 – annualized to be $56, right in the zone of the consensus number for the full year. Well, if the actual results are coming in at 10% higher, then $14 becomes something closer to $15.50, which pushes the annualized number to approximately $62. Accordingly, investors might want to consider the following:

If companies can produce results that are 10% above estimates in the dismal and economically stressed second quarter of this year, what are they likely to do as the global economy continues to make progress toward stabilization and growth? Moreover, what are the likely corporate results for 2010 when the bulk of the US fiscal stimulus package (some $700 billion) kicks in?

Under such conditions, it is conceivable that the $75 S&P 500 operating earnings estimated by the folks over at Goldman (noted in my Tuesday blog posting) may actually be more than a touch on the low side!

Investment Strategy Implications

Stocks are extremely overbought and a move below 900 for the S&P 500 (versus a surge above 1000) is still the higher probability at this time. However, it is advisable that investors understand and respect the potential of a period of explosive earnings from now through the end of 2010.

While much can happen between now and then, the results for 2Q09 produced thus far are providing the evidence of such a scenario – one that is not on the radar screen of most investors, analysts, and investment strategists.

*Sam Stovall, S&P, July 22, 2009

Minyanville article: Three Reasons Investors Should Curb Their Enthusiasm (for Financials)

"Investor spirits for Financials may have been buoyed by the recent earnings results of the major banks, however, there are at least 3 reasons why such enthusiasm should be tempered. Let’s start with the dustup that's emerging between fund giant BlackRock (BLK) and the investment banks."

To read the complete Minyanville article, click here
To view all Minayanville postings, click here

When Goldman Talks, Investors Listen

For the past two months, I have made the argument that above consensus macro economic data would lead to above consensus earnings results and that investors would see the evidence of this as 2Q09 earnings season got underway. Based on the reports issued thus far, this argument has won the day as above consensus earnings results have matched the above consensus macro economic reports preceding them. Accordingly, stocks responded.

The second part of my argument was that such positive data would eventually encourage bottom up analysts (along with many investment strategists and top down economists) to reassess their more cautionary views and begin to raise their full year earnings expectations for this and next year. This, too, has begun to occur – none more significantly than from the investment strategy folks over at Goldman.

In a research report published yesterday, the Goldman strategists raised their estimates of S&P 500 operating earnings for this and next year - from $40 to $52 and from $63 to $75, for 2009 and 2010, respectively. In the process, the group estimated the target fair value for the S&P 500 at 1060 – ten points above my best guesstimate for the year (as reported in the Wall Street Journal on December 30, 2008) and my more evolved view of the same number based on the simple math of the historical average P/E of 15 times a mid 2010 estimate of $70 = 1050. As John McLane (“Die Hard”) might say, “Welcome to the party, pal”.

With Goldman in tow and many fence-sitting traditional money managers and individual investors being forced to reconsider the wisdom of leaving $3.5 trillion in money market funds earning 0.1%, the more meaningful investment strategy question is “Where are we in the stock market cycle?”

Investment Strategy Implications

As expressed in this week’s research report to subscribers, stocks are clearly in extreme overbought territory at the top end of the range. A completed bottom has not occurred. Therefore, stagnation (at best) or a pullback (most likely) appears to be in the very short-term offing for stocks.

That said, each week provides more evidence that the global economy has moved further away from the economic abyss of early March. Now that monetary stimulus and creative governmental action has done its work, the bulk of the fiscal stimulus package (conveniently timed for the 2010 election cycle) will provide the needed power to move the economic needle from stabilization to growth.

Aided by the global growth story (from emerging economies) as well as the likely positive forces of the wealth effect (from higher financial asset values), corporations, having demonstrated their ability to manage solid results in times deep economic distress, should be able to generate very satisfactory earnings results in an overall improving global economic climate - including a modest contribution from the US consumer.

So, where are we in the stock market cycle?

Stocks appear to be well into a transitional phase – one in which sector (style, country, and regional) rotation will (must?) produce the new leadership necessary for a new bull market to sustain itself to 1050 and beyond. The rotation to new leadership coupled with a completed bottom are the stock market signs most worthy of investor attention.

Minyanville article: Why The Bear Will Become The Bull

My article for Minyanville this week puts in context the above consensus macro economic and earnings reports, the bottom building process for stocks, and the transitional nature of the economy and markets.

To read the complete Minyanville article, click here
To view all Minayanville postings, click here

Beyond the Sound Bite: An Interview with Todd Harrison

My wide ranging interview with the Founder and CEO of Minyanville includes the potential of a retest of the March lows, the importance of the US dollar to asset price changes, the "age of austerity", the value in financial innovation, and the importance of being a contrarian investor.

All Beyond the Sound Bite podcast interviews can be found at beyondthesoundbite.blogspot.com
To listen to this week's interview, click here

2Q09 Earnings Season: So Far, So Good…

…but still too early to ring the bullish bell.

As earnings season begins in earnest and will soon kick into high gear, the fundamental valuation proof for equity prices’ faith (since early March) in an improved corporate profitability environment is the central issue at hand for investors. To justify current prices, second quarter earnings results MUST demonstrate that companies can turn in profits above consensus earnings expectations in an overall weak economic environment.

If 2Q09 results come in above consensus estimates (which are around $14 operating earnings for the S&P 500 - see table to your left), then stocks have a solid leg to stand on from which higher prices can follow as the second half of the year unfolds. Such a performance would signal that companies are able to produce sound earnings growth and profitability from the global economy while developed economies, such as the US, struggle with recessions followed by below potential growth.

Operating efficiencies, enhanced by recessionary-induced cost cutting, coupled with exposure to developing economies (which is where the global growth is and will be for the foreseeable future) are the ingredients for the potential of above consensus earnings results.

Conversely, should the numbers in the quarter just ended come in at or below consensus expectations, then concerns re valuation are justifiable. The valuation math in the near term is therefore not encouraging for the bullish case. To illustrate, take a moment to review the above table from this week’s “Sectors and Styles Strategy Report”.

The operating estimates for the S&P 500 for 2009 are in the mid $50 range. With the index at 900, that produces a 16.4 times P/E. Given the fact that the historical P/E for the S&P 500 in normal times is 15, it is hard to get overly enthusiastic for stocks with an above average P/E in less than normal times - which then brings into play the economic weeds that seem to be flourishing among the so-called green shoots.

Investment Strategy Implications

If companies cannot produce above consensus results (via global growth and operating efficiencies) and given the fragile state of the US economy, the suggestion is that the economic weeds that may strangle the US may also inhibit corporate growth and profitability such that earnings results will not justify even an average P/E.

The earnings results issued from several high profile names is, thus far, encouraging. However, as is the case with the technical analysis of stocks and the incomplete bottoming process, investors are well served to see how this plays out over the coming weeks as the earnings season provides more clarity on corporate profitability and the valuation justification for higher stock prices.

Beyond the Sound Bite: An Interview with Sam Stovall

The Chief Investment Strategist at Standard and Poors returns for his third "Beyond the Sound Bite" interview, which includes a prospective correction to the 800 - 825 range for the S&P 500, Info Tech's recent strength and the classic rotation to early cycle sectors, why higher quality sectors have been and remain the investment place to be in the current market climate, and the economic transformation of the US economy.

Beyond the Sound Bite postings can be found at beyondthesoundbite.blogspot.com
To listen to this week's podcast interview, click here

The Head and Shoulders Rorschach Test

In case you hadn't noticed, there’s a big head and shoulders debate brewing. A bona fide bulls versus bear story.

One side (the bulls) sees the stock market world from a decidedly more optimistic perspective with the potential of an upside breakout and a stock market run to new recovery highs. This view is exemplified by the first chart with the neckline somewhere around the 950 level (S&P 500).

Then there is the more pessimistic crowd who see the glass half empty with the threat of a downside break below the 880 level and the potential retest of the lows of early March (second chart above). The same price data but seen from different time perspectives.

In both cases, old school market technicians will tell you nothing can be concluded UNTIL the pattern is complete, meaning that the neckline has to be broken and the ensuing move underway. It is most interesting that all this is occurring just as the markets enter the all-important earnings season and the fundamental justification for higher (or lower) prices, the answers to which we will receive in the coming weeks.

Investment Strategy Implications

Anyone who has read the technical analysis side of my work these past years knows that I am not a big chart pattern guy. No doubt there are those who have found a way of producing a better than 50/50 chance of predicting future price actions via chart pattern analysis, however, I am not one of them.

In my experience, the vast majority of chart patterns are like a Rorschach test – you see what you want to see. Frankly, the only consistent justification that I have found for paying any attention to chart patterns is the simple fact that many others pay attention to chart patterns, which then moves chart pattern analyses to the behavioral science realm – the study of your fellow investment rats and how they run the maze.

From the more bullish perspective (which is where I sit), the completion of a market bottom would be signaled by an upside break above the neckline. As I have written several times before, that would be the sign for the old school technical analysts to ring the bottom-has-been-seen bell. BUT, as noted above, that cannot/should not be done before the fact.

Or, to quote that investment sage, Yogi Berra, “It ain’t over ‘til it’s over.”

Beyond the Sound Bite: An Interview with Dr. Neal Soss

My interview with the Managing Director and Chief Economist with Credit Suisse includes the 2Q09 end to the US recession, expectations of a sub par recovery of 3 1/2%, a sustained level of relatively high unemployment, and a potential compositional shift in the US economy.

Beyond the Sound Bite postings can be found at beyondthesoundbite.blogspot.com
To listen to this week's podcast interview, click here