CI Outlook - Archives

August 2010

At its current level of 1120 the S&P 500 is flat for the year, and down about 5% for the last three months.  An anxious market is reflected in the volatile price action and light trading volume.  Much of this extreme uncertainty is headline related, concerning events in Washington or concerns about a “double dip” recession.  The markets current price-earnings ratio is indicative of an economy in deep recession, with little hope of recovery.  In short, the mood is dour, investors are expecting the worst.  With expectations so low we question the probability of a large downside move in the stock prices.

Upon studying the earnings for the S&P 500 we conclude that even a “double dip” recession should not cause a more than a 20% decline in prices.  We arrive at that conclusion by comparing S&P earnings with current and historical PE ratios.  At its current PE of 13 the market is close to the 12 PE accorded a market with no earnings growth.  A drop in price-earnings from current level of 13 to 12 times earnings would lower the S&P about 15% to 950.  In comparison the average market PE since WWII is 15.  At 15 times earnings the S&P would trade at 1200, up about 8% from current levels.  Furthermore, analysts expect 2011 S&P earnings to approximate $100.  Discounting that to $90 and applying a 15 PE we get an S&P of 1350.  This is important because the market is starting to discount next year’s prospects and work the new higher earnings into its valuation.  So, with earnings expectations this high and investor psychology so low we are fairly confident that the worst has been seen for this market cycle.  However, because the market is so volatile we may get one more shakeout.  If so, we expect to move into a more fully invested position as suitable investment opportunities become available.

As always we thank you for your business and look forward to answering any questions or concerns you may have concerning your investment portfolio.  Please call or come by anytime.

 

CJ Brott

PS.  Karen is in Alaska but will be back soon

 


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