The Enterprising Investor’s Guide 4-20-2009

The price-to-peak earnings multiple advanced slightly in the last week to 9.7x. This valuation multiple is inching closer to double digits as the recent market advance has made this metric bounce from the lowest levels in decades. Considering that the earnings of the S&P 500 have fallen quite a bit since reaching their peak almost two years ago, we expect to see the price-to-peak earnings multiple stay at these lower levels for at least the next two quarters.

Speaking of earnings, earnings season is in full swing and it appears an overarching theme has taken hold. A quarter ago, the common thread in earnings was the tendency of companies to not issue guidance. This was because of uncertainty about the economy and no sense of recovery in the near-term. That rejection of guidance prompted many analysts to become very bearish on the first half of 2009. Which leads to the theme that has begun to develop for this earnings season and that is earnings are better than expected. Many are taking this as a sign that we have reached a bottom, but that is not necessarily the case. When you set the bar low enough, anyone can clear it. More about this: This Earnings Season: Better Than Expected.

S&P 500

The percentage of NYSE stocks selling above their 30-week moving average has rocketed to 54%. Consider this: prior to the current six week rally, the last time the market had back-to-back positive weeks of trading was in September. And in the September advance, the combined two week return was barely over 1%. This rally is something far different, as stocks are up nearly 30% off the lows and have enjoyed the best six week run since the 1930’s.

However, we are always very skeptical when a clear consensus appears to have formed among investors. The market appears to be far more bullish than at anytime during the recession; but the rally has been built on fairly weak participation looking at volume. Everyone keeps referring to “green shoots of spring” in the macro-economy–which are a welcome precursor to recovery–but we remain more than a little bit skeptical.

There is a conventional wisdom that the market makes its bottom about six months prior to the economy’s nadir. This idea is bantered about and taken as fact for nearly all recessions…

While we are not saying that it isn’t possibly true in this case, according to Dr. John Hussman, this is a myth that has very little basis in fact:

“Put bluntly, the economy is not improving, and it is not likely to improve within a few months, because we have far more defaults, foreclosures, and credit excesses to work through. It is simply not true that the stock market heads higher 6 months before the economy bottoms. That simplification was true of 1970 and 1975, but not much else. Rather, there is enormous variation, and about the only reliable tendency is that stocks are usually advancing strongly within about 3 months of a recession’s end. That said, in the 2000-2002 plunge, the market didn’t bottom until about a year after the recovery started.”


The Enterprising Investor’s Guide 4-20-2009

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.

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