The price-to-peak earnings multiple for this week dropped considerably to 11.6x as of Friday’s close. Investors were taken on a roller coaster ride at the end of last week, as Thursday was the best day for U.S. equities in three months following a upside surprise to third quarter GDP results showing the first economic growth in the U.S. in the last year. This quarter benefited greatly from government stimulus like Cash for Clunkers. However, U.S. equities followed up on Friday with a massive sell-off that more than wiped away all of the previous day’s gains. The VIX volatility indicator, often referred to as a fear index, clearly spiked at the end of the week.
Friday marked the end of the fiscal year for mutual funds and perhaps these big money investors sold to lock in profits. Also, it would be normal to expect some selling after the largest gains in some time that the market posted on Thursday. However, we are sensing a shift in investors risk appetites as well and this is not a good sign for a market in an overbought condition. Earnings results have largely continued to improve and come in ahead of expectations, but the market has become harder to please as it justifies the rally that has now spanned nearly 8 months. Any reminder that recovery could be slower than expected will be met with resistance from the market these days. In addition, we are seeing renewed pressure on lenders as the third bailout of GMAC was announced on Friday, which in combination to CIT Group (CIT) filing for bankruptcy on Monday suggest more trouble looms. We continue to believe that the market is vulnerable to a correction.
The percentage of NYSE stocks selling above their 30-week moving average has dropped to 79% this week. The sell-off was widespread on the NYSE with only 370 advances versus 2823 declines over the week, but the financials took the brunt of the beating on renewed credit concerns. Despite the return to a more normal level of sentiment after a prolonged period of extreme bullishness, our investor sentiment metric remains precariously elevated.
Last week’s reading on consumer confidence came in lower than expected, which sent the market lower on the news. The lack of confidence among consumers could become a very real problem this holiday season as retailers need a strong showing in the all important season. With unemployment showing no signs of rebounding to job growth before the end of the year, many people have become more likely to constrain spending this year. As the government begins to evaluate options for backing out of its interventions in the economy during “The Great Recession”, the consumer will once again become the focal point where economists look for growth. All signs we are seeing suggest that this growth could be sluggish, and will require an improvement in the household balance sheet which remains strained.
As our readers know, we are advocating a defensive posture towards this market, but that does not mean that we are advising selling out of the stock market completely. From an asset allocation perspective, there is a lack of attractive alternatives for capital right now that offer an enticing return. This market may continue to head higher into the future, but on average we would prefer to take some risk off the table in this environment. We would not be the least bit surprised to see a correction in the market to reflect the ongoing economic difficulties facing us, and as we have seen over the last year losses can be rapid and devastating to long term returns.
