The Enterprising Investor’s Guide 4-27-2009

The price-to-peak earnings multiple remains unchanged from last week at 9.7x. The rally that spanned six straight weeks came to an end with last week’s small decline. This week will test the bullish run that the market has held since the beginning of March and earnings will continue to be in focus during the week ahead. Thus far we have seen many companies report better than expected results; however, much of this estimate beating comes from analysts’ expectations being extremely low. A perfect example of this is Whirlpool (WHR) who reported sales were off about 23%, yet the company beat earnings estimates by more than a dollar. They were supposed to lose about 18 cents per share, but EPS came in at 91 cents. Obviously, the stock is getting a boost (up 18%) from the earnings beat but sales are slumping and earnings are still down from last year. The vast majority of companies are experiencing serious declines in their fundamentals, but so far the market remains resilient to the otherwise bad news.

Over the next two or so years, we expect to see broader equity valuations remain lower than we were used to seeing at the height of the bubble. Record earnings were achieved in the summer of 2007 on a massive amount of debt, both corporate and personal. Current debt outstanding in the economy remains unsustainably high at more than 3.5 times our nation’s GDP. At the same time, personal savings has gone from a net negative to a net positive of about 4% as consumers get more cautious about the future. There is little doubt that the economy will continue to deleverage for at least the next year or more. It is difficult to make the argument that corporate earnings will be able to return to record levels in this environment.

S&P 500

The percentage of NYSE stocks selling above their 30-week moving average increased again last week and stands at nearly 60%. This sentiment indicator has taken a huge upswing in the last two months, which indicates an overbought condition, at least in the near term. For further evidence of this, the market recently peaked at over 80% for the number of stocks selling above their 50-day moving average. Historically speaking, the 80% threshold is the point where many bull market rallies begin to lose steam. With that being said, we are not comfortable making predictions about the short term direction of the market.

The market has shown surprising strength in the face of continued bad news, and that sort of behavior could continue. However, there appears to be significant cause for caution in the current market environment.


Clearly, this week will be a major test for the legs of this rally. In addition to earnings shedding more light on the operations of major companies, there is a new element introducing uncertainty into the market this week as the fear over the swine flu outbreak in Mexico put pressure on the market Monday. If the flu continues to spread and make headlines, the market will almost certainly take a hit as there is uncertainty over how such an outbreak could impact international commerce.

As for Ockham’s take, for the investor with a long term focus, our asset allocation model has become less bullish as compared to two weeks ago. In the midst of this nearly 30% rally in stocks, we have lowered our equity stance from overweight to in-line with a normal allocation target. With many of the same problems that led to the market’s decline such as foreclosures and unemployment remaining a serious threat to the economy, there are other very serious concerns with consumer credit and commercial real estate that are beginning to get attention. In our opinion the market seems to overbought and has potential for a significant pull back.

The Enterprising Investor’s Guide 4-27-2009

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.

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.

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