Summer Trading Takes Hold
These columns are becoming a bit tough,
simply from the standpoint of going over the previous day’s action (there is not
much), and I sound like a broken record saying trade assertively in the first
hour, then back off. In fact, I even contemplated sending in yesterday’s
piece to see if anyone noticed.
At any rate, the grind continues. It appears that summer trading has gripped
the market (although many will debate that it began months ago) and lack of
conviction rules the day. I actually find the price action a bit troubling.
Sure, summers are always slow, but there are a lot of things hanging over this
market that make me uncomfortable. Until they are sorted out, I do not expect
this apathy to go away.
- Weakening dollar
- No sign of an earnings pick-up
- Investors finally becoming skeptical of a turnaround
- Valuations (there is that nasty reference to fundamentals) are still out
of whack
In fact, on May 24, 2002, the San Francisco Federal
Reserve released a study (click
here to read it) with some rather humbling insights. Despite the Fed’s
prediction of blue skies and sunny days, they are also woefully aware of some of
the excess which still exist in this market.
“Since 1982, there has been a six-fold
expansion (from 7.5 to 46) in the “multiple” that investors assign
to each dollar of reported earnings. This expansion helped to produce an
extraordinary compound annual return on stocks of 15.2% over the period. Given
this record, future movements in the P/E ratio (or lack thereof) will likely
play an important role in determining how well stocks perform in the coming
years.
“Making predictions about the stock market
can be a humbling experience. Still, it may be worthwhile to consider the
model’s predictions for the year-end 2002 level of the S&P 500 index.
Given a current 20-year government bond yield of about 5.5% and employing the
end-of-sample volatility measures for stocks and bonds, the model predicts a
P/E ratio of 24.1. Applying this multiple to the S&P’s estimate of $36.34
for reported earnings in 2002 yields a predicted value of 876 for the index —
about 20% below the current level. Different predictions would be obtained if
any of the model inputs (for example, the bond yield or the earnings forecast)
were to change significantly over the coming year. Also note that the market
has deviated from the model’s predictions for sustained periods in the
past.”
These quotes are just that, quotes. However, one always
needs to be aware of all potential scenarios when putting capital to work. Sure,
most of us laugh and shake our heads when people mention fundamentals and market
history, but remember this, history has a nasty habit of repeating itself, and
for me, there is just a bit too much risk on the downside for me to be
aggressively long this market. Incidentally, the second quote refers to
projected earnings on the S&Ps for 2002 of $36.70. I do not know about you, but
that is a 49% increase from 2001, which seems a bit optimistic to me. In
fact, Nortel (NT)
just said they do not see a recovery in their business until 2003-04.
For me, I am still placing my money on the short side
while maintaining longs in select gold stocks. Sure, call me a bear. I just call
them as I see them.
Key Technical
Numbers (futures):
S&Ps |
Nasdaq |
| 1111 | 1318 |
| 1098-1100 | 1288-91 |
| 1088 | 1273 |
| 1081 (key resistance) | 1258-60 (confluence) |
| 1068-70 (confluence) | 1230 |
| 1052-54 | 1218 |
| 1045 (contract low) | 1188 |
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As always, feel free to send me your comments and
questions. See you in TradersWire.