Wednesday, January 27, 2010

Beyond the Sound Bite: An Interview with Richard Bernstein

My interview with the former chief investment strategist with Merrill Lynch, who has gone and set up shop at Richard Bernstein Capital Management, includes a "wildly bullish" view for 2010. Need I say more?

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

Tuesday, January 26, 2010

Correction Now? Not Likely Without the Set Up.

There are certainly many justifiable fundamental reasons for stocks to take their long overdue (and healthy) corrective tumble right now but in one important aspect such a decline is not likely to occur just yet – the set up is absent.

It is an extremely rare occurrence when a meaningful correction (10%+) occurs without certain market preconditions in place prior to the decline. Absent these preconditions, market declines have an “out of the blue” quality to them and tend to be limited to the 3 to 5% range. The rationale for the preconditions (the set up) is rather straight forward – before a trend reversal can take place, weakness must begin to emerge so that the apparent forces that drove prices higher were actually exhibiting signs of exhaustion when one looks beyond the headline major indices. Typically the signs of weakness are most apparent in the form of divergences – price action divergences between the major, headline indices and other important sectors of the market.

The first chart above (click image to enlarge) shows that such a divergence had potential in November into December last year but was clearly resolved to the bull case before the year was out with higher highs being made with all size indices confirming. As the chart clearly shows, however, no such divergences preceded the current drop*.

Another aspect of the set up is the price point at which the decline takes place. For example, when a decline begins at a price point of no consequence (e.g. NOT at a moving average) the decline again has the features of an “out of the blue” style drop. Moreover, it always adds power to the decline argument when price crosses a key moving average, such as the 50 day moving average, at the same time the 50 day crosses the longer term 200 day moving average. (This is what some call the “golden cross”, which I have labeled a mega trend reversal.)

The second chart above makes this quite clear as the US market is a long way away from producing such a reversal signal. Price has broken its 50 day moving average, but it has done that several times before**. Moreover, price is well above its 200 day moving average and the 50 day is a long way from crossing the 200 day***.

Investment Strategy Implications

While there are many fundamental reasons for equities to decline (over valuation being one of them), the technicals of this market do not argue for a sustainable decline at this time.

*The same conditions are found when comparing US to various global indices.
**The above chart is only the last 6 months. Since the bull rally began in early March 2009, price has crossed the 50 day 3 times.
***The correction case would morph to the bear case should price remain below both moving averages and both moving averages point downward. Hence, the mega trend reversal.

Wednesday, January 13, 2010

Beyond the Sound Bite: An Interview with Justin Fox

The economic and business columnist for Time and popular blogger's recent book, "The Myth of the Rational Market", is the focus of this week's interview. Areas such behavioral finance and how investors might consider ways to navigate an investment world turned upside down now that key principles such as the efficient markets hypothesis and CAPM are under siege is explored and discussed.

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

Beyond the Sound Bite: An Interview with Dr. Kent Moors

“If you think the run up to July 2008 was a wild ride, you haven’t seen anything yet.” So said this week's guest referring to the energy price run to record highs in 2008. In my interview with the professor of political science from Duquesne University and internationally recognized expert In global risk management, oil and natural gas policy and finance, cross-border capital flows, we explored his comprehensive approach to energy analysis and why he believes energy prices are in for an even more dynamically volatile period ahead.

Dr. Moors is also president of ASIDA (an international consulting firm specializing in former Soviet, Caspian, and other developing markets) as well as Executive Managing Partner of Risk Management Associates, International, a full service global management consulting and executive training firm.

The length of the interview is 19 minutes 12 seconds.

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

Tuesday, January 12, 2010

Doing the Valuation Math

Now that my market forecast events have begun (with NYSSA's event last Thursday), it's time to do a little valuation math for the year ahead. So, based on the initial comments heard at last week's event and elsewhere, here you go:

18 times $80 (S&P 500 operating earnings for 2010) = 1440.
1440 minus a present value discount (12%) = 1267

This is the bulls’ case for why stocks should go higher this year – an above historical average P/E times a robust earnings growth for 2010 minus an historical average discount rate (bringing the future value back to the present*) equals a most profitable year.

The valuation debate is a paradox – simple yet complicated. Simple in that the formula is rather easy to compute. Complicated in that the social science known as investing involves numerous variables, many of which are highly subjective. For example, the P/E used in a valuation model is based on the views of the investor for the economic and market times of the moment and the near future. In the current case, the bulls would argue that an above average P/E is appropriate for the current and near future because history says so – low inflation + robust economic growth + strong corporate balance sheets = above average P/Es. Exactly what level above the historical average P/E (which happens to be 15) is the subjective wiggle room and a key area of the valuation debate. Then there is the earnings number.

$80 operating earnings for the S&P 500 for 2010 is the best case number I am hearing of late. Of course, this number is open for debate. The final two components that investors might want to ponder doing the valuation math involve the discount rate and the time period.

In the above illustration, I used the historical average return for large cap stocks, which has often (but not always) been 12%. Some would argue that 10% (or lower) is a more appropriate going forward expected return for stocks given the slow growth environment envisioned for the next several years for advanced developed economies. Then there is the time period one discounts the future value. In the above case, I use 12 months. Some might argue things are far to dynamic and a 6 month discounting time period is more appropriate.

Investment Strategy Implications

Wherever you fix the fair value of today’s market, the valuation math always needs to be done as it provides the return context for an asset. For what it’s worth, I think these times are extraordinary and do not warrant an above average P/E (which signifies a below average risk climate). Rather, I would argue the uncertainty factor for 2010 is considerably higher than the bulls believe, despite the prospects of a robust earnings period for the large cap, multinational companies that populate the S&P 500. Risks in areas broad (e.g. geo political, US domestic political, developed economies’ internally generated growth) and specific (e.g. sector specific issues such as those facing the financial services and healthcare industries, sustainability of Chinese growth, regulatory change) are abundant and should be ignored at one's financial peril.

All of this leads to the more prudent conclusion that an average P/E times a moderately higher earnings growth rate is appropriate. In other words,

15 times $74 = 1110
1080 minus 12% = 977

Therefore, at today’s price of 1140 the market is currently 14% overvalued.

Liquidity driven markets have a funny way of producing overvalued markets. And an even funnier way of producing justifications for just about any fantasy valuation levels one wants to concoct. At least for a while.

*Note: It is important to remember that on any given day stocks sell at a discount to their expected future value. Therefore, today’s price is always a discount to where stocks should be in the near future.

Wednesday, January 6, 2010

Beyond the Sound Bite: An Interview with Tim Hayes, CMT

We get the year started with yet another most informative and insightful interview (my third) with the Chief Investment Strategist for Ned Davis Research as we discussed his year ahead outlook, one that includes an up first quarter followed by a likely mid year major correction culminating in a year end rally. Such a scenario will require a much more actively adept investor seeking to generate alpha. We also explored the context within which the current market falls: the cyclical bull within a secular bear market.

The length of the interview is 14 minutes 50 seconds.

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