The price-to-peak earnings multiple dipped to just 11.5x–its lowest point since last October.  Equity markets sold off strongly in the face of renewed concerns about foundering US economic growth and the anemic performance of the labor market.  Government statistics revealed that non-farm payrolls actually declined in June for the first time this year, which is quite uncommon for economies in the early stages of a recovery.  After all is said and done, equities gave back 12% in the second quarter, reversing the trend of four straight quarters of market gains.

The stock market appears to be at an inflection point—one which likely will set the tone for the second half of the year.  If current analysts’ earnings estimates turnout to be anywhere close to accurate, then stock valuations appear to be increasingly attractive.  Valuations are particularly enticing for the largest US stocks, many of which are trading at only about 10x one-year forward earnings estimates (XOM, IBM and T for example).  However, many of these estimates have been based on previous assumptions of US growth that could be a bit aggressive.  Should we see companies fail to meet the raised earnings bar or analysts’ estimates trending lower, then we would expect another down-leg for equities.

The percentage of NYSE stocks trading above their 30-week moving average dropped below 35% following last week’s more than 5% decline in the S&P 500.  A burgeoning number of pundits are now predicting a “double-dip” recession in some form or another.  Meredith Whitney claims that a double-dip in housing is already underway and the persistent weakness in private sector job growth has turned many bulls to bears.  Also, global concerns regarding the ongoing sovereign debt crisis in Europe and a suspected bubble forming in Chinese real estate have global stock investors on edge.  With all the fear, uncertainty and doubt looming around the financial markets, it seems to us that investors will need reminders that things are in fact getting better with each passing day.  Third quarter earnings season begins next week, but we believe that stocks will be in a “show me” state of mind, and we don’t mean Missouri!

In sum, there is plenty to be concerned about in this market and we are certainly worried by the back-pedaling now underway in many critical areas of the economy.  For that reason, we urge investors to stay nimble and hold a healthy chunk of riskless assets (cash) in this environment.  The potential for swift declines, as we saw last week, is still very real.  However, as a value investor with a long term focus, we also realize that valuations are becoming historically very compelling.  Furthermore, investor sentiment has steadily drifted lower over the last two months and clearly is tilted towards the bear’s side.  Historically speaking, these conditions normally present a great opportunity to selectively buy quality stocks.  With this in mind, we remain cautiously optimistic regarding equity markets.