Pivotal Stock Market Earnings Season

Dshort.com published an interesting article recently that calculated what is known as the P/E10 of the S&P 500. The P/E10 is essentially the current real price of the index divided by the average earnings over the past 10 years. Benjamin Graham created this ratio to be a more robust measure of the market’s value, as during times of extreme market fluctuation the regular trailing P/E is prone to somewhat illogical results. For example, the market currently shows a trailing P/E of 137.3, obviously due to the severely depressed earnings we’ve had this past year as well as to the recent run-up the market has seen in anticipation of future earnings. What is somewhat disconcerting is that the P/E10, while showing a more reasonable P/E of 19.1, still indicates the market to be overvalued in a historical context – the historical average P/E10 is about 16.3 while that of the trailing P/E is 15. This is even after the worst stock market decline in recent history; perhaps the stock market is getting ahead of itself?

Many of us will be watching for evidence of increased revenues this quarter, alongside hopefully increased earnings. Last quarter's earnings may have met already decreased expectations, but much of the earnings came about by way of cost cutting rather than top line growth. Since businesses likely had a stronger call to action for cost cutting than ever in our recent history, I would be surprised if the majority didn’t trim all that they could as quickly as they possibly could. Going into this earnings season there likely aren’t too many avenues left to cut costs. If the consumer isn’t the heavy-lifter this quarter that the market is expecting, and if revenues stay flat or decline as a result, then there isn’t much hope for even meeting expectations this time around. I wouldn’t be too eager to see the effect such a disappointment would have, especially after the strong run-up we’ve just had in the markets since March.

Every time in the past that the P/E10 went from the 1st to the 4th quintile (quintiles divide the P/E10 into 5 groups with the 1st being the highest P/E group and the 4th being the lowest P/E group) it’s ultimately declined to the 5th quintile where it bottomed in single digits. In March, the P/E10 of the S&P hit the 4th quintile after a long way down from the 1st and we are currently back into the 2nd quintile where the market is looking expensive. If a drop to the 5th quintile was to occur, it would come about from either a decline in the S&P to below 600 or alternatively from a strong resurgence in corporate earnings. If Q3 earnings didn’t have you waiting in anticipation before…

As an aside, in the past these declines have lasted anywhere from 3 to more than 19 years. The current decline is in its 9th year. I wonder how long earnings can remain weak for until the market decides to take fate into its own hands. In this environment I wouldn’t bet on it taking its time.

Less Room to Fall for Value

Today was not a good day for the markets, to say the least. These daily market fluctuations don't faze value investors though, due to the conviction we have in our investments' true worth.

Recently I recommended an investment in Lockheed Martin Corporation (NYSE: LMT). Since it's a high conviction investment of mine I tend not to follow the daily ups and downs in the share price. Rather I keep an eye out for any new press releases or industry news that may cause a significant change in the model. Today, however, I couldn't help but notice that while the S&P was down by more than 2%, my investment in LMT was actually up 0.83%! Granted, this is a daily fluctuation that I already stated no interest in, but barring significant news one would expect a large-cap security like this to move along with the market.

I would like to believe that LMT didn't suffer along with the rest of the market because it is one of the truly undervalued stocks in today's speculative and possibly overvalued market. While we value investors don't give notice to daily fluctuations in share price, it comforts me to know that we probably do have the upper hand when the market decides to go south.

Insiders Indicate Better Valuations Ahead

Insider selling to buying is at a new high as public company insiders are locking in profits from the recent market rally. Insider selling is currently more than 33 times the value being bought. At the same time the S&P is up almost 50% from the March 9th lows and trades at a trailing P/E of 18.5. It's interesting that insider buying has been weak since April as insiders don't seem to have jumped on board the rising market. This bearish signal sure doesn't add any strength to whatever foundation the market rally may be built on.

As mentioned in an earlier article, there may be some volatile periods coming up in the markets. Insiders aren't demonstrating the kind of confidence in their companies' prospects that the rest of the market is; this may be a sign of the volatile periods ahead as the market reevaluates its views on future earnings.

If you find value in this market then buy it. But for those that are having trouble finding value in this inflated market, there is a possibility some of the buying opportunities seen during the March lows may come around again.

Source: TrimTabs via CNBC

It's Well Past May; Should You Still Go Away?

The markets have seen a run-up of over 40% since their lows in March. According to Bespoke Investment Group the S&P has reached its highest P/E since the end of 2004, due to a combination of market optimism without the earnings to support it. It may be getting very difficult to find value plays out there as a result. There may be hope yet though for those of you who wish you had jumped on the many opportunities back in March.

A recent article by my friend and professor Dr. George Athanassakos brings to light the oft spoken phrase - sell in May and go away. According to Dr. Athanassakos there is no reason to believe this year will be any different than what has been seen on average over the past 50 years. Even though the recent bull market has coincided with the beginning of the notoriously difficult May to October period "we are not out of the woods yet", as Dr. Athanassakos says. Due to various market behaviors, which can be read about in the article, it may be time for institutional money managers to lock in their profits from the recent rally. He also points out that September and October are traditionally two very volatile months.

Supporting Dr. Athanassakos' views is the fact that the consumer has some heavy lifting to do for earnings to catch up to the recently inflated price levels. That may be a stretch in the midst of consumer concern over high unemployment rates.

While many opportunities to invest in solid value back in March may have been missed, opportunity may present itself again sooner than you think. I wouldn't go anywhere just yet.

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