All Eyes Watch for Earnings
Research for Online Investors

by John Dalt

7/12/10

The market is wandering what to do.  Are we on the verge of a bull market taking us to new highs, or is the Bear going to plunge us to new lows?  Low volume tips buyers hands; animal spirits have not been present for some time.  Volume seems to dry up as stocks move higher, only increasing on the way down.

The Wall Street Journal polled some market analysts.  Thomas Lee, chief U.S. equity strategist at J.P. Morgan estimates the S&P 500 will reach 1300 by the end of the year.  Tom Villalta, lead portfolio manager of the Jones/Villalta Opportunity Fund sees 1230 by the end of the year.  Jim McDonald, chief investment strategist at Northern Trust Global Investments predicts 1000 to 1200 by year end.  Tobias Levkvich, chief U.S. equity strategist at Citigroup Global Markets believes the market could see a rally if Republican momentum continues to build around the Congressional elections.  He predicts the S&P will finish the year at 1175.  He goes on to say “We think that there’s likely to be a rally later this year.  The summer will still be kind of rocky.”

One way to value the S&P is based on the earnings estimates of all the stocks in the index.  We can value the index the same way we would value an individual stock.  If XYZ company earns five dollars, what is the company stock worth?  At a 10X multiple, the stock would be fairly valued at $50 per share.  This would conceivably return 10% on your investment.  Your return may come in dividends (if they pay them), share buybacks, or stock price appreciation.

We can believe other market participants will see our stock as undervalued if it has a lower multiple than other stocks.  This leads us to expect our stock to appreciate in value against other stocks that do not earn as much as a percentage of their stock price.

The average S&P 500 P/E ratio since 1935 is 15.6.  The average since 1988 is 23.1 The S&P is trading today at 1077, this calculates a P/E ratio of 16.17, yielding 6.18%  Looking at these numbers we observe the market is trading slightly above the average for the last 75 years, but well below the multiple for the last 12 years.

Yield on a 10-year treasury bond is quoted today at 3.046%.  The TIP etf currently yields 3.84%  What does the market need to move higher?  In a word; confidence.  Investors need confidence that eurozone countries will bring budgets under control without crashing their economies.  Traders need confidence that China, and other Asian countries, will continue to build exports to Europe and the U.S.  Also, those economies need to continue to develop their own markets, building internal sales.  All participants need confidence that the U.S. government is going to back away from government takeovers, controls, increased regulation and higher taxes on business.

We need to watch earnings for the next three weeks.  Perhaps more important are the forecasts.  Companies tell us what they believe the rest of the year looks like.  Great earnings but conservative forecasts could cause the market to roll over.  If we get good earnings from most companies, and generally upbeat forecasts the market may rally.

A general rally could bring money off the sidelines as some investors won’t want to be left behind.  There are also significant short positions on many stocks.  Short covering can act like rocket fuel if the market moves higher.

We will bring you our impression of important earnings reports as they are announced.

To the mailbag:
I read an article on Bloomberg that really caught my eye.  I think it fits right in with your line of thought on market direction.  If your interpretation of the charts is right, does it make sense to go to cash before it is too late?  I am in my 70’s and don’t want to wait for five years to recoup.---paid up subscriber J.P.

John’s reply:  J.P. if you have followed our recommendations in the long term portfolio we are 65% invested at the present time, with two of our stocks on $trail stop.  We have sold some at the top of the market and some on trailing stops.  We have put a hold on any new buys.  I don’t think I would get completely out of the market.  If you decide to sell out, we will signal the time to buy.  It may not get you the lowest price, but we want to wait until we feel safer.  The remaining stocks we have are good solid companies, with good dividends.  I hope this helps you.

Editor’s note:  Our long term portfolio is 7% ahead of the market half-way through the year.  You can read more here, and sleep better at night.

The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions.  It may contain errors and you should not make investment decisions based solely on what you believe you have read here.  Do your own research, it is your money.  If you lose it, it is your responsibility, not ours or your grandmothers!  The editor may or may not have a position in any securities discussed.  The editor may have held a position in a security earlier, or in the future.

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