The Enterprising Investor’s Guide 5-4-2009

The price-to-peak earnings multiple advanced slightly to 9.8x as of last week’s close. The recent market advance has been very rapid as the S&P 500 is up more than 30% from the bottom roughly two months ago. After experiencing two of the best performing months in stock market history, we no longer regard the overall market as undervalued. That is, unless you believe that the market will return to the record earnings levels of the summer of 2007 in short order. The rally has been impressive in terms of breadth as advances have far outpaced declines. Although participation has been widespread, volume has not been especially impressive. As advances/declines can often be considered the breadth of a rally, volume is a characteristic akin to the depth of a rally. In this respect, the current rally is not overwhelmingly impressive.

There is still a lot of money sitting on the sidelines as Bloomberg pointed out last Friday in its “Chart of the Day”. The data compiled by Investment Company Institute shows that there is more money in money-market funds than in equity funds for the first time since 1991. Furthermore, the amount invested in money market funds reached 49% of the market value of U.S. equities in March, which is a record. These statistics suggest, as the Bloomberg article did, that “catch up buying” could help extend the rally. That is certainly a possibility as investors have become less risk averse in the last few weeks and with risk-free assets having very unattractive yields, more investors may be anxious to put money to work in the market, despite the return to less attractive valuations.

S&P 500

The percentage of NYSE stocks selling above their 30-week moving average is 68% this week. Rarely have we ever seen such a decided shift in investor psychology, as we have experienced in the last two months. Investors have shown the propensity to take on more risk of late, as there are signs of stabilization in many areas of the economy. However, we are always likely to take the contrarian approach when the market has settled on a consensus. The term “green shoots of Spring” has been repeatedly employed by journalists and analysts to describe the underlying cause of this rally, but these “green shoots” are still extremely vulnerable.

We still see reason to believe that the market could have significant downside as foreclosures are still happening frequently and, in some cases, they are accelerating (Rising Foreclosures Prevent a Full Housing Recovery). Furthermore, many analysts, even bullish ones, believe that unemployment will continue to worsen, which will have adverse effects on both residential and commercial real estate as well as consumer credit. In the end, a worsening of the foreclosure and unemployment situations could quickly put a lot more strain on the banks. Previews of the government’s stress tests have already found that at least 6 of the 19 largest banks are insufficiently capitalized should the economy worsen. Make no mistake there is still significant risk to the financial sector and investors in the next few quarters.


Interestingly, Ockham’s asset allocation target has lowered its equity portion of the model to its lowest levels since in the summer of 2007. At that point in 2007 and now, we are advocating a 90% of target equity allocation. So, if your portfolio is normally 50% equities, you may want to move 5% to either cash, fixed income, or another asset class. The implicit meaning is that investors should consider taking some gains off of the table. We are not advocating a drastic move out of equities, but by our methodology it appears prudent to take some profits while still participating in the rally in case the “catch up buying” does extend the rally.

The Enterprising Investor’s Guide 5-4-2009

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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