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
