Merrill’s excellent strategist, Richard Bernstein, has news for those who think the market has bottomed: It hasn’t.
You’re all waaaaaay too eager to buy the dip, Rich says, and your bullishness is a decidedly bearish indicator. Contrary to popular wisdown, it’s also better to be late than early:
Our indicators are improving as a result of the equity market’s downdraft, but they are not yet giving an “all clear” signal.
We have previously said that we would follow four main indicators to gauge our re-entry point back into the equity markets. They are sentiment, valuation, estimate revisions, and jobless claims. Let’s review where these indicators now stand.
Much to our shock, sentiment actually deteriorated slightly rather than improved last month [translation: investors got more optimistic]. Our model is picking up that investors are willing to “buy on the dip”. Historically, significant market bottoms have not been associated with such bullishness.
Valuation has demonstrably improved, but valuation was so extreme that it is now only beginning to approach fair value. At the end of August, our models were suggesting that the equity market’s valuation was extreme, and similar to the valuations seen at such notorious market tops as August of 1987 and March of 2000. The equity market is nowhere close to such extremes any longer, but it is not yet undervalued. There are certain sectors within the equity market that do appear undervalued to us and Consumer Staples and Health Care continue to head the list. We will be updating our estimate revision work within the next week, and it will be interesting to see if downward revisions start to overshoot.
Finally, the leading indicators of employment continue to erode. We continue to focus on employment because we think stabilizing household cash flow might be critical to eventually solving the global economic crisis.
Overall, the backdrop for equities is improving from the extremes of two months ago. The key question is when do the expected returns outweigh the risks imbedded in the economy. The popular press is full of reports of famous investors moving back into equities. However, history shows quite clearly that being early can carry substantial performance penalties. Despite the popular consensus, it’s historically been better to actually be somewhat late.
We continue to rely on our indicators to guide our way. Until they show us that the risk/returns are skewed in investors’ favour, we are happy with our current themes: Treasuries and very high quality bonds, developed markets, defensive sectors, and secure high quality dividend paying stocks.
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