Monday, 22 August 2011

After tumble, stocks may see short-term rally

Bloomberg reports that the losses suffered by the US stock market over the past four weeks were the biggest since 2009.

U.S. stocks tumbled, sending the Standard & Poor’s 500 Index to its biggest four-week loss since March 2009, as concern the global economy is stalling overshadowed the cheapest valuations in 2 1/2 years...

The S&P 500 lost 4.7 percent to 1,123.53. It has sunk 16 percent since July 22 as about $3 trillion was erased from the value of U.S. equities, according to data compiled by Bloomberg. The Dow Jones Industrial Average fell 451.37 points, or 4 percent, to 10,817.65 this week, extending its four-week decline to 1,863.51 points...

The S&P 500 has fallen 18 percent from an almost three-year high on April 29 amid concern about Europe’s government debt crisis and a global economic slowdown. The decline through Aug. 8 drove the index to a valuation of 12.2 times reported earnings, the lowest level since March 2009. Its price-earnings ratio is now 12.3, compared with the average of 16.4 since 1954, according to data compiled by Bloomberg.

However, Andrew Smithers, who famously wrote in 2000 that the US stock market was overvalued just before it plunged, thinks that US stocks remain overvalued. From Bloomberg today:

Smithers said in a report dated Aug. 15 that the S&P 500 is still overvalued by about 43 percent relative to earnings for the past 10 years, a time frame endorsed by Yale University’s Robert J. Shiller. Relative to the Q ratio, a comparison of market value with the replacement cost of assets, the index is about 36 percent too high, he said.

“Investors should not, in general, buy stocks at this level, as the stock market is likely to become cheap at some time during the next 10 years and there is therefore a high risk that anyone buying today will lose money before they start to get a positive return,” Smithers said. “In these circumstances, they are likely to be better off by holding cash until the market has fallen.”

Still, Smithers thinks that a short-term rally is likely.

Companies are cashed up and likely to buy back shares at a time when price-to-earnings ratios are low, providing a trigger for a short-term rally, said Smithers, who claimed stocks were overvalued in 2000 before a near 50 percent decline over 2 1/2 years. Investors should sell shares once their holdings gain 10 percent...

Another analyst who thinks that there is scope for a short-term rally in stocks despite poor valuations is John Hussman. In his latest commentary today, he writes:

Despite prospective long-term returns that remain quite thin on a historical basis, some segment of investors may be willing to accept market risk in stocks and utilities based on comparative returns in an environment where Treasury yields are abominably depressed and distorted. On a long-term basis, I think that significant exposure is an mistake, because it relies on risk premiums to stay compressed indefinitely. Even so, on a near-term basis we've observed enough of a decline to taper our disdain for market valuations at least modestly. On the technical side, short-term market action is extremely compressed and oversold. Also, we saw a variety of "non-confirmations" last week - downside leadership eased, trading volume tapered off, new lows in more volatile indices such as the Nasdaq and Dow Transports were not confirmed by new lows in the S&P 500, Dow Industrials, or Dow Utilities, and so forth.

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