Stock Markets Expensive on Falling Corporate Earnings Basis

By: Paul_J_Nolte

Nothing to see here…just move along was the phrase du jour, as investors seem to look past still higher unemployment claims (due to Chrysler plant/dealer closings) and lower retail sales. While the markets declined, it seemed to be due to a lack of interest as volume declined than “hard-core” selling. This week will bring more data on the housing sector, which should set the tone for the remainder of the month, as little in the way of earnings or significant economic data will be released on the holiday shortened following week.

Inflation, a huge concern a year ago as energy prices were scaling the heights toward $150/bbl are now merely a blip on the screen. Wage growth is outpacing inflation, so for those working, their purchasing power is actually increasing. Through it all, consumer confidence is rising, as measured by the University of Michigan to the highest level since September. Encouraged by the “green shoots” of recovery, it is hoped that they won’t wither under the summer sun!

As we discussed last week, the markets failed to move above their 200-day moving averages, which is seen as an important distinction between a bull and bear markets. It could be that the markets are taking a collective breath before embarking upon another surge higher, something that bears watching this week. However, one item caught our attention from the Standard & Poor’s website. Earnings on the SP500 have fallen to under $8 per share – meaning the PE ratio of the SP500 is over 100 based upon Friday’s close.

Earnings have declined by 90% since their peak in October ’07, however are estimated to rise to over $40 by the end of 2009, still giving an over 20 multiple to the market at today’s prices – hardly a bargain. Historically, the markets will bottom around 10x earnings and if history holds, we could see the SP500 cut in half on top of the 40% decline from last year. Unless we underestimate the strength of the recovery, the markets could be in for a long and hot summer.

The only positive reading left in the bond model is corporate bonds. Commodity prices have moved a bit higher as have long-term yields. Although they declined toward the end of the week, it was likely in reaction to the weak stock market. We do expect bond yields to remain within a very wide trading range as investors move from stocks toward the safety of bonds or sell bonds in reaction to the very high government issuance of treasury securities. The shorter end of the yield curve is likely to be fairly stable, although at low yields. The Federal Reserve is trying anything/everything to get investors to move to equities, including providing next to no yield on three-month treasury bills.

By Paul J. Nolte CFA
http://www.hinsdaleassociates.com
mailto:pnolte@hinsdaleassociates.com

Copyright © 2009 Paul J. Nolte - All Rights Reserved.
Paul J Nolte is Director of Investments at Hinsdale Associates of Hinsdale. His qualifications include : Chartered Financial Analyst (CFA) , and a Member Investment Analyst Society of Chicago.

Disclaimer - The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present or future financial market conditions.

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