The Enterprising Investor’s Guide 2-16-09

The price-to-peak earnings valuation metric fell to 9.3x as of the close on Friday, this ties for the second lowest market valuation to date in this bear market. Valuation for the S&P 500 looks very appealing on a historical basis, when utilizing peak earnings, but if you were to replace the normalizing peak earnings with simply current earnings the market does not look quite as cheap. By our calculation earnings have dropped dramatically by more than half of the peak earnings level of the summer of 2007. Using the simple, yet more unstable current price/ current earnings then the ratio is about 19.05x. Given the uncertainty of current earnings estimates which may be bottoming or could still have further to fall, the market may not be finished retracing to a more justifiable level on this basis.

John Hussman, who developed the price-to-peak earnings multiple, has previously stated that price-to-peak earnings ratios under 10x are a relatively attractive valuation point, but the price to peak might reach as low as 8 in deeper downturns. For those of you wondering, what price the S&P 500 would need to drop to in order to have a price-to-peak at 8, it would need to be 714 or a decline of 13% more from this point.

S&P 500

The percentage of NYSE stocks selling above their 30-week moving average is 14.6%, which is a slight decline from last week. Again, there is no surprise here that investor sentiment is at a very low level as the market continues to be relatively range bound since the market bottomed in the unbelievably ugly November. Earnings reports have yielded few individual companies that are thriving right now, and macroeconomic data have continued to slide as well. The hopes for an Obama bounce have come and gone, and the big news from last week was the markets disapproval of Tim Geithner’s first speech as the head of the Treasury Department. The speech did not indicate that an aggregator bank a.k.a. “bad bank” was likely going to be a part of the new plan. Otherwise, the speech was light on details and referenced the possibility of spending another trillion dollars on a bank rescue plan. After the highly anticipated speech, the S&P 500 plunged about 5% on that day as an already uncertain near future became even more clouded. Apart from that one day, the markets were nearly even for the rest of the week.


Our asset allocation model remains bullish at current valuation and current sentiment levels. In the past when low valuation have been accompanied by low sentiment levels, it is a justifiable time to be in the market. However, this instance warrants increased caution as so much of the market action has very little to do with the underlying fundamentals. For example, with the unprecedented level of government intervention in this market, the stock market responds to what is going on in Congress far more intensely than a blue-chip company missing earnings. Now, as much as anytime since the Great Depression, we are dealing with a political economy. So, stock markets will be tremendously unpredictable in the short term, over the long term we have to believe that we are at least near the lows.

Equity Allocation

About Ockham Research 645 Articles

Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

We utilize this straightforward approach to value over 5500 securities, with key emphasis given to the study of individual securities' price-to-sales, price-to-cash earnings and other historical valuation ranges. Our long term value investing methodology is powered by the teachings of Ben Graham and it has proven to be very adept at identifying stock prices that are out of line with fundamental factors.

Ockham Research provides its research in a variety of forms and products including our company specific reports, portfolio analytics tools, newsletters, and blog posts. We also offer a white labeling research solution that can give any financial services firm their own research presence without the time and cost associated with building such a robust coverage universe of their own.

Be the first to comment

Leave a Reply

Your email address will not be published.