The price-to-peak earnings multiple dipped to 12.0x to start the month of February. At 12x peak earnings, stocks have reached a level that we normally consider relatively attractive. We continue to see a recovery in reported earnings, which are finally starting to normalize after the enormous write-downs in late 2008 and early 2009. These write-downs brought trailing 12 month-reported EPS for the S&P 500 down to under $10 per share at the nadir. The trailing 12 month earnings number, while well off its previous peak levels, has tripled from its lows as S&P 500 companies have collectively produced $29.50 a share over the last year. This is evidence of a marked improvement in earnings; however, we remain cautious since earnings remain at only one-third of their peak levels although forward earnings estimates anticipate substantial further improvement.
Although on average earnings are coming in ahead of analysts’ estimates, we remain wary of the market’s overall valuation. The recent bull market has run strongly for nearly 11 months, and we think a breather is in order. When looking at breadth statistics over the last few weeks, volume on down days far surpasses that on up days. Therefore, one could surmise that sellers are far more convinced of the correctness of their position than are buyers.
The percentage of NYSE stocks selling below their 30-week moving average slumped 23% during the past two weeks to just 63% today. Recent market weakness has brought our market sentiment metric down from very lofty levels. We view investor sentiment as one of the most important factors driving the market over the past year, as we observed a massive swing from hyper-bearishness to bullishness. As long time readers are aware, we are always skeptical when sentiment levels reach extremes on either side. We expect further normalization in this metric over the coming weeks, but it is no longer at levels that suggest the market is overbought.
We reaffirm our defensive posture regarding stocks at this time even though there are clear signs that economic fundamentals have begun to improve. In our view, the market has already priced in a strong recovery, since even positive earnings surprises have done little to please the market over the past few weeks. We have…
thought that a correction was imminent for some time, but make no prediction of how deep it will be.
For further reading, we highly recommend John Hussman’s weekly market comment which looks at the S&P 500’s current valuation from the perspective of book value. As you will see, this is a very reasonable way to estimate future long term returns, and the current S&P 500 to book value is at a very unappealing level.
