The price-to-peak earnings multiple fell to 9.5x after the S&P 500 shed another 4.5% last week. The price-to-peak multiple is being compressed by the ongoing bear market because S&P aggregate earnings are down 35% from the August 2007 high. Peak earnings were reached at the height of the credit bubble. With de-leveraging in full force, it will be some time before we reach such lofty earnings levels again. We expect that earnings will continue to deteriorate over at least the next quarter or two before beginning to ascend gradually later in 2009. Thus, it is clear that the price-to-peak earnings multiple will likely remain at a lower level than we have become accustomed to over the last decade or so. Unfortunately, we may see current earnings crater to half of the peak level before all is said and done. As such, while stock prices are appealing from many valuation perspectives, the market’s price-to-peak metric will likely remain unusually low for quite some time.
The percentage of NYSE stocks selling above their 30-week moving average is 9.5% this week. We consider anything below 30% to be a contrary bullish indicator and anything below 10% merits an aggressively bullish stance. However, over the past four months we have seen a sustained period of very bearish sentiment, with the nadir being reached in October. While we still believe that it is wise to be on the opposite side of prevailing conventional wisdom, it is clear that investor concerns are going to persist until there are concrete signs of economic improvement. Although, trading at such a depressed price-to-peak earnings level is normally an aggressive bullish indicator it is fair to say that we are not in a normal market and thus we believe that investor caution is warranted.
Our asset allocation model is advocating above-normal exposure to equities for those investors that have a long-term, value investing mind-set. Investing with this strategy takes discipline, as value investors have gotten crushed in this market downturn. Even though we believed the market was overvalued at its heights in 2007, the speed and intensity of the downturn surprised us. So much so that our valuation metrics–which give significant insight in normal market conditions–have lead us astray from time to time in this downturn. However, we stand by the famous Ben Graham saying, “In the short term the market is a voting machine, but in the long term it is a weighing machine.” So, by this logic, we may not be the world’s best market timer, but we think it is fair to say that fundamentally strong companies will benefit nicely when the market starts to recalibrate based on fundamentals rather than succumbing to extreme volatility driven by fear and uncertainty about the future. We will continue to recommend companies that are growing sales and earnings (there are still some out there) and companies whose balance sheets have gobs of cash and little debt.