As stock prices made new highs this week, a frequent media theme was that this was happening — drum roll!!!! —- in spite of the fundamentals.
If you listened to the accompanying discussion, you eventually learned what was meant by “fundamentals.” For many observers it is some kind of unquantifiable headline risk. As long as there is something to worry about, something to call a “headwind,” then this viewpoint means that “the fundamentals are bad.” The parade of pundits warns that you should make sure that all of these risks have been resolved before investing. Don’t hold your breath waiting for that!
The big reason that traders are missing the rally is that they mis-define “fundamentals.”
Comparing to the 2008 Highs
I lost count of the stories saying that we were back to the 2008 highs. Danger! The idea seems to be that we all remember what happened then, so watch out! We also have triple tops and the like. (Whatever happened to the Death Cross and the Hindenberg Omen?)
So I did some checking.
May of 2008. Forward earnings on the S&P 500 then were 93.77, the 10-year yield was 3.9% and the odds of a recession — according to the best method — were nearly 100%
Now. Forward earnings are 108, the 10-year yield is 1.59% and the recession odds for the next year are below 10%.
People talk about headlines and sling around phrases like Draghi put, printing money, etc., instead of
analysing data. The world is a much better place for investing than it was in 2008.
(This is not a political blog, and the comparison to four years ago relates to the market, not the election cycle. I am well aware that the mileage has varied for many people. Most folks do not have significant stock holdings. At “A Dash” we aim to engage in successful investing no matter who is in power).
The Failure of Static Analysis
The bogus fundamentals of the “headwinds pundits” never change. They can always complain that there is too much debt and too much government.
They are basically in denial about the power of government and central banks. Put aside your political viewpoint. Go ahead and cheer when Rick Santelli tells you that this is all a “sugar high” but put emotions aside when investing.
Meanwhile, Rick is not a candidate to get on the FOMC — nor is Ron Paul. Furthermore, if Romney is elected we will see someone who shares the Bernanke philosophy. But that is a subject for another day.
Your assessment of the fundamentals should change with events, represented by actual data!
If you do not have your head in the sand, you are watching the events in Europe. On Thursday, the Spanish 10-year yield is down to 6.02%, down 59 bps. This is important for the ability to refinance debt, and much lower than the touted “danger zone” of 7%. On Friday, Italian 10-year yield now 5.02%. Spain at 5.57%, down another 39 bps. This is not the point of the curve where the ECB proposes to buy.
This is market data, confirming what I have been telling investors for nearly a year with the decline in the St. Louis Financial Stress Index.
If you are following the data, you know that the world is a better place for investors now than it was a week ago. It is much better than it was four years ago.
The fear premium in the market is still very high. I know that many investors (mistakenly) think that it is too late to buy stocks since we are at the old highs.
This article is for you!
I use the one year forward earnings from the “bottoms up” estimate from Thomson/Reuters. Many critics take the inconsistent position that forward earnings are too optimistic, but explain the typical 70% beat rate by saying that estimates are guided down. I have written about this at length and challenged the sceptics. I maintain that there is a point where forward estimates by bottoms-up analysts are quite useful — the best we can do. That point is approximately one year ahead. I continue to invite any loyalist for another method — particularly those espoused by Hussman or Shiller — to show that they can predict earnings one year in advance with greater precision.
With this in mind, the “Jackson Hole” forward earnings yield was 8.31% and it has declined to 7.74% now. When compared to the 10-year yield (interest rates in the table) the risk premium was a huge 5.75% last Fall and is still 4.61%. On a long-term basis this is a juicy premium unless risk is huge.
All of the metrics are better now than they were at the prior market top. This is why stock prices increase over time — the fundamentals, defined correctly, get better.
If I had to pick one stock right now that reflects the changes, it would be Aflac (AFL). The earnings and dividends are great. The valuation is low because of excessive fear about Europe, where the company has invested insurance premiums. Cyclical stocks like CAT are great and I still like tech stocks like ORCL. There are many names consistent with this theme.
These stocks have bounced from the lows, but you are not “chasing.” The valuation is still solid and I buy them for new clients on day one.
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