Acamedia may say neither fundamental nor technical analysis can beat the market, yet I am still a fundamentalist.
S&P 500 P/E did dip to 7 before. But with market risk premium constantly declining in the past fifty years or so, S&P 500 has been trading at 15 times of earnings on average. So as S&P 500 companies are expected to produce a collective $94.81 of earnings per share (EPS) in 2009, and the index closed at 903 today, implying an 09 fwd P/E of 10. This is 35% of cheaper than historical average. But is it really?
Wall st analysts have been slow in adjusting their earnings. Acamedic research shows the aggregate sell side analysts forecasts are no better than projected through simple extrapolation. In fact, the way it works is that the sell side analyst picks the EPS and target price (TP) first, then his associates would fudge the model to produce the same numbers.
This may mean the market is efficient enough that it is almost impossible to have an information edge. This is where the story that a monkey throwing darts at WSJ picking stocks can do as well as a pro is from. Besides, if you are really the smartest, why would you sit long as a sell side analyst with a miserable life and limited financial upside? You would be long gone running your own funds or at least be on the buy side.
Currently Wall st analysts still expect S&P 500 earnings to grow 32% YoY in 4Q08 and 15.7% in 2009. This is why 09 fwd P/E stands only at 10 and is 35% discount to historical average. Now with more gloomy outlook on global economy that prolonged recession may go well into 09 before a slow recovery in 2010, I expect a flood of news that sell side analysts aggressively cut earnings should come in the next few months. Assume earnings are cut 30% for next year, then S&P is not really that cheap. Of course whether it is cheap or not also depends on your view of how quick the economy would recover. Assume a dividend yield remains the same and P/E ratios neither expand nor contract, if you expect a fast recovery from a short and shallow recession, then S&P 500 is cheap. Otherwise you should wait six months and see what the new government would do.
Similarly, a flight to quality explains the recent strengthening of USD and the tank of emerging market debts, stocks and currencies. With so much money repatriating to US, we would expect the US market should have taken off. But it did not. Why? The reason might be the funds are still on the sidelines: if redemptions, sell the stocks;otherwise sit on piles of cash. Maybe you should do the same.
Similar stories exist for EU markets. Sell side analysts expect European company earnings to increase by 10% in 2009 while equity strategists expect to fall by about 40% instead. I don't believe this scenario is fully priced in today, meaning more rough waters ahead.
1. Wall Street analysts lag badly as outlook worsens
http://www.reuters.com/article/newsOne/idUSTRE49S6OF20081029?pageNumber=1&virtualBrandChannel=0
2. Wave of profit warnings expected
http://www.ft.com/cms/s/0/adcb8bb2-a39d-11dd-942c-000077b07658.html
