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What the Market Wants: Volatile Market Might Be Pounding Out a Bottom

Posted on the 23 August 2011 by Phil's Stock World @philstockworld

Courtesy of Scott Martindale, Senior Managing Director, Sabrient

What the Market Wants: Volatile Market Might be Pounding Out a Bottom
Volatile Market Might be Pounding Out a Bottom

Editor’s Note:  David Brown is on vacation.  Scott Martindale, Sabrient’s senior managing director, is this week’s guest editor.   Scott handles institutional sales & marketing for Sabrient. He also writes the weekly Sector Detector and manages the virtual Select Opportunity Portfolio.

Yet another volatile week is behind us. The elevated volume of the prior week gave way to more modest volume early last week, but market weakness on Thursday and Friday brought back the heavier volume. The perma-bears and fear-mongers have been coming out of the shadows in greater numbers like zombies in a horror movie. This must mean that stocks are getting close to a bottom.

The VIX (CBOE Market Volatility Index – a.k.a. “fear index”) closed today (Monday) at 42.44, which is high, and the TED spread (indicator of credit risk in the general economy) has been going straight up since its V-bottom on July 29, closing today at 31.35 – its highest level in over a year. This indicates a rising worry about bank liquidity and a preference for the safety of Treasuries over corporates.

Our Federal government is as dysfunctional and confrontational as it has ever been, and the start of the election cycle may only make things worse. Dollars have been fleeing equities in favor of Treasuries and gold. Even cash doesn’t seem safe, so gold has been on a tear as a traditional safe haven on fears of global financial distress, illiquidity, and stagflation. The underlying problem seems to be public mistrust of governments and financial institutions.

The Financial sector has been at the forefront of the volatility, showing up as either the best or worst performing sector almost every day (and they were the weakest sector again today). Although Sabrient’s SectorCast model indicates that Financial ranks among the highest on a forward-looking basis, many of the large bank stocks are rated “very aggressive” in their accounting and governance practices, which makes them relatively risky as individual investments. Few carry Buy ratings in the Sabrient Ratings Algorithm.

Here are the market stats.

 

Despite the threat of renewed recession, we are in an environment in which the multinational corporations (including banks) are making record profits and sitting on record amounts of cash. Repatriating revenues in foreign currencies into U.S. dollars has been a boon for them. The majority of corporate earnings reports have shown companies beating analysts’ estimates for the second quarter. So from the standpoint that stocks go up as earnings go up, stocks look relatively cheap, and in fact, analysts are sticking with their forecasts of improving earnings for the third and fourth quarters and for 2012.

Sabrient’s David Brown recently pointed out in this column that the average forward P/E ratio for Sabrient’s top-ranked 100 stocks is normally between 7.5 and 8. At the 2011 market top on May 2, the average forward P/E for those stocks was a relatively speculative 8.7. Last Monday, David reported that it had dropped to 6.2, and after today’s close, the average forward P/E is about 5.6. This is a very compelling number.

Furthermore, with the S&P 500 at 1124, the forward P/E indicates a multiple of less than 10x earnings estimates for 2012, and perhaps 15x for recession-adjusted estimates for 2012. (The current P/E relative to trailing twelve months (TTM) earnings is about 11.2.) Also, the current dividend yield on the S&P is on par with 10-year T-bonds in the 2.1?2.2% range, which is bullish given that the “normal” for the S&P 500 dividend yield has been in the range of 1.6-1.9. Moreover, dividends are taxed at 15% while interest is taxed at up to 35%.

This is why many of the renowned deep-value investors like Warren Buffett are buying. That’s not to say that we don’t have more downside in the near term, with stocks getting even cheaper. But assuming no Armageddon, valuations are compelling, and there really is no alternative “safe” place to park money right now. Real estate is illiquid and still looking as though the bottom is not yet in. Treasuries are holding up for now in spite of the U.S. debt downgrade by S&P, but the threat of increasing interest rates will keep downward pressure on bond prices. Gold is still on a tear, but few people would speculate on gold with much more than a small portion of their portfolio. The dollar is weakening, so even cash is a poor investment. If you aren’t putting money into the stronger foreign currencies, then solid stocks — particularly those paying a dividend yield and those with strong exposure to overseas markets — appear attractive on a relative basis.

The S&P 500 continues to bounce along near its lows for the year, and today (Monday) closed just below 1124. Many chart-based technical indicators have been oversold for an extended period, and the market seems overdue to put in a technical bottom near current levels and attempt a more sustained rally. The important 200-day simple moving average is all the way up around 1285. However, last week the chart gave us the dreaded “death cross” in which the 50-day simple moving average crossed down through the 200-day MA. So, there will be some strong technical resistance to break through if the market indeed tries to rally.
On a separate note, investors have continued to find some solace in the diversification and ease of trading offered by exchange-traded funds (ETFs). BlackRock reported that the ETF industry in the United States had 1,039 ETFs and assets of $973 billion from 29 providers as of June 30, 2011. This compares to 846 ETFs and assets of $693 billion from 30 providers one year ago. New exchange-traded funds (ETFs) continue to be filed and launched, with most designed to track an index. Sabrient continues to grow its presence as an index provider for ETFs.

Upcoming Economic Reports
Tuesday, 8/23 New Home Sales
Wednesday, 8/24 Durable Goods Orders
Thursday, 8/25 Initial Jobless Claims
Friday, 8/26 GDP
Consumer Sentiment
Monday, August29 Personal Income/Outlays
Pending Home Sales Index

4 Stock Ideas for this Market

This week, I started with the High Growth preset search in MyStockFinder. I also included Buys (in addition to Strong Buys), and slightly up-weighted Technicals. Here are four stock ideas from the four top-ranked sectors in Sabrient’s forward-looking SectorCast model:

HollyFrontier (HFC) – Energy
MasterCard (MA) – Finance
First Majestic Silver (AG) – Basic Industries
Sturm Ruger (RGR) – Consumer Durables

Until next week,


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