Meanwhile, we are wasting a terrific earnings season with 61% of the companies reporting beating estimates, while 68% beat revenue estimates. The result has left the S&P 500’s (SPX/1199.38) earnings estimates for this year nestled around $100 and pushing towards $114 for 2012. If those estimates prove correct, at last week’s intraday low (1168.09), the SPX was trading at a PE multiple of 10.3x next year’s earnings, with an Earning’s Yield of ~9.8% ($114 ÷ 1168), leaving the Equity Risk Premium for stocks at ~7.4% (Earnings Yield – 10 year T’note yield of 2.4%) for the highest ERP in a generation. This implies either earnings estimates are too high (I don’t believe it), the country will slide into recession (I don’t believe it), or stocks are undervalued (my position). Hence, if you did not raise some cash last February – March as recommended, I think it is a mistake to do so here since we should get some kind of rally either off of last week’s low, or a low early this week. In that rally, it will be important to monitor the market’s internal metrics with an eye towards pruning underperforming stocks from investment accounts. While my hunch is last week’s Dow Theory “sell signal” will prove false, like the one that occurred during May 6, 2010’s “Flash Crash,” I would still tread carefully “living forwards.”
The call for this week: For weeks I have stated that a credit rating downgrade was a fait accompli and possibly already discounted by the markets; this morning that doesn’t seem to be the case with the pre-opening futures down ~30 points. Whatever the various markets’ near-term reaction, the fact is that everyone is merely offering their intelligent guesses as to the outcome of this historic “downgrade” event. One thing I do believe is what I wrote last week, which is likely a catalyst for the downgrade (as paraphrased):
“While I don’t embrace the Tea Party, their ‘sea change’ is palpable. Nowhere is this more apparent than the current Debt Ceiling debate. The Tea Party seems to have surfaced our nation’s ‘political corruption,’ which hinders the proliferation of prosperity. Interestingly they are not the first, for such thoughts were first scribed by Adam Smith in his book The Wealth of Nations (1776). Whether you like, or hate, the Tea Party, there is definitely a palpable change afoot that over the long-term could be extremely bullish for the economy, the stock market and our country.”
In conclusion, I leave with these thoughts from legendary investor Jim Rogers:
When asked how he made his money, Mr. Rogers answered, “I sell euphoria and buy panic.” The way he determines that is to wait until prices are “gapping” in the charts. Gapping on the upside is “euphoria,” while gapping on the downside is “panic.” Currently, gold and Treasuries are gapping on the upside; and, stocks are gapping on the downside. The implication, even though I believe gold is in a secular bull market, suggests partial positions should be sold in precious metals and the freed-up cash should be used to “buy” fundamentally sound stocks with decent dividend yields. Obviously, the weeks ahead will determine if this is the correct strategy. All said, IMO it is too late to panic. The time to panic, and raise cash, was months ago (we did). Now it is time to selectively redeploy that cash into select equities.
P.S. – I am in Chicago this week speaking at conferences, seeing institutional accounts, and presenting at seminars for our Financial Advisors. Hence, I leave you with Vladimir Lenin’s quote, “There are decades when nothing happens; and, there are weeks when decades happen!” Clearly, the past few weeks “speak” to that quote, even though it wasn’t intended for the stock market! Accordingly, we are buyers on weakness in select equities . . .
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Copyright © Raymond James
