Hear that noise?
It’s the sound of folks rushing optimistically back into the stock markets of the world.
According to the May 11, 2009 Wall Street Journal, Russia’s stock market is up 45% this year, Brazil’s stock market index is up 75% since its October low, China’s market index is up 44.2% year to date, and Taiwan’s is up 43.4% over the same time frame.
Are these gains likely to continue? Will US Markets be next to rebound?
In my view, not likely.
While the worldwide rebound in stocks over the past couple of months has been a welcome relief for investors, in my view it’s probably not sustainable, longer term, for a couple of reasons.
First, in the same issue of “The Wall Street Journal” mentioned above, there was a small article on the front page of the “Money and Investing” section. The “Ahead of the Tape” feature by Mark Gongloff and Jeff D. Opdyke was titled, “Deflation May Be Down But Not Out”. In the short article, the authors point out falling food and energy prices have pushed down global inflation and they believe this trend will likely continue. Furthermore, Barclay’s Capital economists expect the US, UK, Eurozone, and Japan to rack up negative year-to-year CPI ratings through at least September of this year. (CPI is the measure of inflation most commonly used. A negative rating means falling prices which is deflation defined.)
Central banks around the world hate deflation. Deflation causes many consumers to park cash on the sidelines and not spend money, slowing economic growth and hindering corporate profits – the all important metric for investors when determining their investments. It’s this deflation fear that has caused central banks around the world to engage in ‘quantitative easing’ – central banker talk for printing money. The idea is that if enough money is printed and readily available, folks will start spending it and the deflation monster will go away. So far that hasn’t happened.
If corporate profits don’t rebound, in my view many stock prices are overvalued. Take the US stock markets for example. When looking at the profits of S&P 500 companies, you’ll get a feel for current stock valuations. In the May issue of “Insight,” Gary Shilling’s terrific newsletter, he points out that his earnings forecast of $40 per share for S&P 500 companies is looking entirely more likely. Since November, as Shilling correctly points out, many other forecasters have revised their earnings estimates downward – with many getting closer to his $40 per share earnings estimate.
I happen to agree with Shilling. And, if we’re right, what does a $40 per share earnings number possibly mean for current stock valuations?
If we assume (and this is an assumption) that a ‘bottom’ in a stock market has a Price to Earnings Ratio of 15, which may be generous since many prior market bottoms had P/E ratios of 8 to 10 and apply the $40 per share earnings number to it, we get a potential value for the S&P 500 index of 600. (I arrived at this number by multiplying 15 times 40 = 600).
If you’re not familiar with the term P/E ratio, it’s the price of a stock per share divided by the annual earnings per share. For example a stock selling for $20 per share with earnings of $1 per share would have a P/E of 20.
Given that the current S&P 500 index value has been floating around 900 or so and applying the market bottom P/E multiple of 15, that would mean that 2009 earnings may need to be $60 per share to support these values, a number that is potentially 50% higher than we could actually realize.
Some folks, in my opinion wise folks, are raising their cash holdings by systematically taking profits from this rally. While I believe we could see a bit of a continuation of this rally, picking exact tops is a fool’s game. For a complete, free market update, click here: www.usawealthmanagement.com.)
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