Fundamental analysis is of some value. We need to take as many objective measurements of markets and prices as possible to navigate our capital through risk assets. The trouble comes when we build our investment case on fundamental arguments without taking into account what price is really doing. This is where I find technical analysis (TA) to be a helpful tool. TA used properly can help us to not lose our grip amid our own arguments and opinions. It keeps us focused on reality rather than on our hopes and beliefs.
This brings me to the trouble with assessing the price or “P” when the “E” or earnings are in a free fall.
Having lived through an asset bubble in stocks from mid 1990’s to 2007, we are now seeing the deflation process play out in real time. While the S&P 500 price peaked at a ludicrous 40 times earnings in 2000 it is tempting to say that a present multiple of about 10 is now looking a lot more promising. 10x is clearly a lot cheaper than 40x without a doubt. But here’s the rub. To estimate a present multiple for the S&P of 9.3x forward earnings we have to use a 2009 operating earnings estimate of $94 a share. This would assume earnings growth for both 2008 and 2009. If we use the lower range of 2009 analyst consensus of $74 a share, the present price of the S&P clocks at almost 12 x earnings estimates. See S&P web site and the Wall Street Journal also The Economic Blue Screen of Death.
I think it is likely that this significant global downturn will knock earnings down considerably further than present consensus estimates. If 2009 earnings were to compress to $50 a share for example, then the S&P at yesterday’s 876 is still trading at a historically lofty 17.5x earnings. If earnings go to $40 a share, then the present PE is 21. These would not be the low multiples likely to launch the next cyclical bull.
The trouble with PE arguments is that we just don't know how low E will go this cycle. We truly have no idea how low, low can go, until it goes taking our capital with it. Only time can answer these questions definitively.
In the meantime, we can use historical averages as a reference point, and we must monitor the technical metrics of the market re-pricing. So far we are simply not seeing signs of the bottom—yet. Selling pressure continues intensely while buying pressure, even on big up days, is anemic at best.
In Roubini is right about the forced liquidation of hedge funds going bust in the coming weeks, it may be some time before this market hits its bottom.
And what about all the people staying in or desperate to jump back in an effort to recoup losses? There is no rush. Once the market does bottom, it will make its way back up over the next 4-5 years. The recovery will not be a sudden “V” shape–of that we can pretty much be assured.
As for those that insist one can't time markets and buy and hope is all we have? They are simply deluded. They still don't realize that we are in a range bound, secular bear market that will cycle back and forth between the 2000 high and the 2002 low for the next 7 to 10 years. It has already done this for the past 8 years, and we are about half way through the roughly 17-year cycle. The trouble with 95% of all investment services, funds and advisors today, is that they subscribe to a passive equity allocation. Their approach is designed for a secular bull climate that we are simply not in.
Cory’s Chart Corner
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