Sunday, August 8, 2010

Itz Weekend Market Review

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Last week Itz posted a video of Gary Shilling making a case for deflation for the U.S. link
In the chart below, it compares the S&P 500 to the 'Rule of 20' since prior to the Depression. Rule of 20 which was used to assess PE multiples given various inflation environments, plots the sum of trailing PE multiples with yoy inflation rates. Note, that before the 1950s when PE multiples were lower. The Depression and a severe deflationary period between 1930 and 1933, and another milder one in the late 1930s, resulted in a dismal decade for corporate profits.

 According to the Rule of 20, with inflation near zero, PE multiples should be anywhere between 15 and 25.
The current CPI stands @ 0.9. link
According to Thomson,
Of the 443 companies in the S&P 500 that have reported earnings to date for Q2 2010, 75% have reported earnings above analyst expectations.
The blended earnings growth rate for the S&P 500 for Q2 2010 is 38%.
The forward four-quarter (Q3 2010 – Q2 2011) P/E ratio for the S&P 500 is 12.7, below the average forward four-quarter P/E ratio of the previous 52 weeks (14.2).

 *prices as of close August 5, 2010
Also looked at a multiple regression analysis that assessed the correlation of core CPI rates with earnings yield of the S&P 500 Index. Withe the core CPI @ 0.9% the market “should be” at a 20. P/E based on the historical statistical best fit between earnings yield and core CPI. That would indicate that the S&P is trading at a 48% discount. Even Doug Kass wrote back in Jun e[at the Doug Kass bottom of '10] with the S&P 500 then at 1030, trading at 11.5 2011 earnings. >>LINK

The outlook now is that the second half of 2010 will not be as robust as expected, that the recovery is slowing. But as recent economic reports have shown, it is continuing to expand and not contract.
The Jobs Report Friday morning was disappointing to say the least, but the late afternoon rally was very impressive. More than likely the markets are pricing in a new quantitative-easing move by the Fed (Tuesday FOMC) this week.

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