Is The Market Really Back? Are the Bulls Back in Control?
The Fundamental Side
We are about one third of the way through June quarterly earnings season. I think it is fair to declare there is a high probability the Bear Market is over. The market is emotionally reactive to short term events, but over the long term generally gets it right. The way the market trades today tells us where we will be in six months.
After three years of total control by the bears, the market decided that the end of the war signaled a turning point in effectiveness of economic stimulus, and has been betting on an economic recovery since the first week of March. Based on June quarterly numbers from about one third of the large cap companies, it seems an earnings recovery is definitely underway. Here are the facts:
As of last Friday one third of the companies trading on the S&P 500 had reported June numbers. According to S&P Global, estimates for the trailing four quarters operating earnings for the S&P 500 is now $47.67. This is the broadest measure of the corporate performance in large cap stocks.
According to Thomson Financial, the current consensus of analysts' estimates for the S&P 500 for the next four quarters is now up to $57.10. Therefore, the market is anticipating operating earnings for the S&P 500 is estimated to be growing at nearly 20%. Earnings growth always leads to appreciating stocks.
I use the operating earnings number because that is the best measure of the true health of a business, and the one the market keys on.
P/E Should Really Be B/S
The Bull/Bear debate rages on. Bulls point to earnings and argue unprecedented fiscal stimulus will work. Bears keep arguing a bull market can't start until large cap stocks trade at a P/E of 8.
I don't know who is right, but I do know this: This single most misunderstood and misused measure of a stock's potential value is the "P/E Ratio". It should really be called the "B/S Ratio".
If you only take one thing from the OTC Journal in all the editions you ever read, take this- The P/E ratio of a stock means nothing. P/E ratio stands for Price to Earnings. Most people believe a stock can be considered undervalued if the P/E ratio is about half the growth rate. Another words, if a company had a P/E ratio of 10, and a growth rate of 20%, it could be considered undervalued.
I first learned the uselessness of this ratio in about 1987. I was considering investing in a stock trading at about $40 per share. A friend discouraged me when I told him the P/E ratio was 2500. He promptly informed me he was a very successful investor, and would never buy any stock trading with a P/E of 2500. He told me I should have my head examined.
Needless to say, the stock traded to about $250 within one year without me. Split adjusted, the stock I was looking to buy at $40 has a current price equivalent of $.50, and is now at $70. The name of the company is Amgen for those who are interested. This is when I learned how useless P/E ratio is as an indicator of future price performance.
In my opinion, the rule of thumb for determining if stocks will go up is very simple. Stocks go up when investors believe the future looks better. Stocks go down when investors believe the future looks worse. Investors started to believe the future could look better last October, and have become more convinced since the beginning of March. Therefore, barring any more cataclysmic events (911, Enronitis, War with Iraq, etc), the market is now prepared to buy into earnings growth after a three year absence.
Right now we are in the midst of the summer grind. Business slows with vacation time. Volume is way down. The earnings you are reading about today were already priced into stocks during April, May, and June. The bond market is catching all the action. Long term bonds are getting clobbered as the market anticipates an economic recovery and higher interest rates in the future.
September is usually is a tough month. I believe October will mark the beginning of a major multi month run up in the markets.
Here's a quick overview of the technical analysis you might find helpful:
A Quick Lesson on the Technical Side
When evaluating the market in general or any stock, there are two sides to look at: the fundamental and the technical. For the most part, traders are only technical. They believe you can predict where a stock will go simply by identifying patterns that repeat themselves, rather than looking at corporate performance. I like a combination of the two methods. I like to invest in companies with a great deal of fundamental upside at a favorable technical entry level.
Market technicians are a strange breed. They claim it's a science, but technical analysis is really an art form. You have to find a style or method that works for you and be disciplined. You can look at stochastics, support/resistance, moving averages, Elliot waves, MACD indicators, candlesticks, Bollinger Bands, oscillators, etc. It is all very confusing, and takes an enormous amount of time and energy to learn.
I use simplistic technical analysis. I like stocks and the market who's highs are getting higher, and who's lows are getting higher. I like trends. Here are the two simple technical factors I like to look at and use frequently for readers of the OTC Journal:
The Support Line
Alongside is a chart of the NASDAQ Composite as measured from the March low when the current uptrend started. The Red line I have drawn in is the support line, which defines the uptrend.
Note that each and every time the market dropped back to that line, it bounced back up. I believe that until this line is solidly breached for several days, the uptrend is still intact. It is amazing how accurately Monday and Tuesday's drop took us right back to the trendline, which was followed by a rebound. This chart tells me the current uptrend is still intact until proven otherwise. This performance, coupled with projections of 20% operating earnings growth for the S&P 500 over the next year, has me convinced the Bear Market is over.
The 50% Retracement Rule
Here's another chart of the NASDAQ Composite with Support/Resistance lines drawn in. I believe this becomes useful when the short term trend line is broken to the downside.
The trendline I showed in the chart above will eventually be breached. There will be a short term trend reversal to the downside at some point in time. I don't know when it will be.
When it happens, I will be looking for the market to give back about 50% of its gains during the life of the trend. 50% is not an exact number, it is a range, which is why this chart has three lines in the middle. Those lines show the range.
Therefore, if the market were to break solidly below the trendline shown in the first chart, I would be looking for a pullback into the middle of the range, or a 50% retracement of the previous gains. If it were to start happening tomorrow, I would look for the NASDAQ to grind down into the 1520 range at which point you would have a low risk entry level. As long as the Bull Market remains intact, another uptrend would begin at some point in the future.
In my opinion, a break below the trendline shown in the first section would not mean the long term trend had reversed. It would simply mean the market was advancing into a long overdue corrective phase, and offer an opportunity to accumulate at reasonable prices.
If the market were to break solidly below the bottom line of the three in the middle, I would start to worry about the validity of this new Bear Market, and might take my money off the table until the smoke cleared.
The charts I have shown you can be drawn any way you want over any time frame, and can be applied to any stock. I believe you should look at longer term charts if you are looking to make longer term investments. For short term investments you should look at short term charts.
There are stocks I plan on owning for three days, and others for three years. Unless I get really lucky, I generally don't day trade. I've tried it, and I'm bad at it.
In the little universe of stocks I cover, you should pick out a few you really like. Instead of buying along with everyone else when there is news and the stock is hot, try accumulating when prices drop to trendlines or 50% retracements coupled by light volume. Sell a little when they trade well to get your cost basis down. If you become good at it, you could own a whole portfolio of microcaps with little or no cost basis. Also, as I learned the hard way from the Amgen story, don't be afraid to own stocks for the long term.
The Fundamental Side
We are about one third of the way through June quarterly earnings season. I think it is fair to declare there is a high probability the Bear Market is over. The market is emotionally reactive to short term events, but over the long term generally gets it right. The way the market trades today tells us where we will be in six months.
After three years of total control by the bears, the market decided that the end of the war signaled a turning point in effectiveness of economic stimulus, and has been betting on an economic recovery since the first week of March. Based on June quarterly numbers from about one third of the large cap companies, it seems an earnings recovery is definitely underway. Here are the facts:
As of last Friday one third of the companies trading on the S&P 500 had reported June numbers. According to S&P Global, estimates for the trailing four quarters operating earnings for the S&P 500 is now $47.67. This is the broadest measure of the corporate performance in large cap stocks.
According to Thomson Financial, the current consensus of analysts' estimates for the S&P 500 for the next four quarters is now up to $57.10. Therefore, the market is anticipating operating earnings for the S&P 500 is estimated to be growing at nearly 20%. Earnings growth always leads to appreciating stocks.
I use the operating earnings number because that is the best measure of the true health of a business, and the one the market keys on.
P/E Should Really Be B/S
The Bull/Bear debate rages on. Bulls point to earnings and argue unprecedented fiscal stimulus will work. Bears keep arguing a bull market can't start until large cap stocks trade at a P/E of 8.
I don't know who is right, but I do know this: This single most misunderstood and misused measure of a stock's potential value is the "P/E Ratio". It should really be called the "B/S Ratio".
If you only take one thing from the OTC Journal in all the editions you ever read, take this- The P/E ratio of a stock means nothing. P/E ratio stands for Price to Earnings. Most people believe a stock can be considered undervalued if the P/E ratio is about half the growth rate. Another words, if a company had a P/E ratio of 10, and a growth rate of 20%, it could be considered undervalued.
I first learned the uselessness of this ratio in about 1987. I was considering investing in a stock trading at about $40 per share. A friend discouraged me when I told him the P/E ratio was 2500. He promptly informed me he was a very successful investor, and would never buy any stock trading with a P/E of 2500. He told me I should have my head examined.
Needless to say, the stock traded to about $250 within one year without me. Split adjusted, the stock I was looking to buy at $40 has a current price equivalent of $.50, and is now at $70. The name of the company is Amgen for those who are interested. This is when I learned how useless P/E ratio is as an indicator of future price performance.
In my opinion, the rule of thumb for determining if stocks will go up is very simple. Stocks go up when investors believe the future looks better. Stocks go down when investors believe the future looks worse. Investors started to believe the future could look better last October, and have become more convinced since the beginning of March. Therefore, barring any more cataclysmic events (911, Enronitis, War with Iraq, etc), the market is now prepared to buy into earnings growth after a three year absence.
Right now we are in the midst of the summer grind. Business slows with vacation time. Volume is way down. The earnings you are reading about today were already priced into stocks during April, May, and June. The bond market is catching all the action. Long term bonds are getting clobbered as the market anticipates an economic recovery and higher interest rates in the future.
September is usually is a tough month. I believe October will mark the beginning of a major multi month run up in the markets.
Here's a quick overview of the technical analysis you might find helpful:
A Quick Lesson on the Technical Side
When evaluating the market in general or any stock, there are two sides to look at: the fundamental and the technical. For the most part, traders are only technical. They believe you can predict where a stock will go simply by identifying patterns that repeat themselves, rather than looking at corporate performance. I like a combination of the two methods. I like to invest in companies with a great deal of fundamental upside at a favorable technical entry level.
Market technicians are a strange breed. They claim it's a science, but technical analysis is really an art form. You have to find a style or method that works for you and be disciplined. You can look at stochastics, support/resistance, moving averages, Elliot waves, MACD indicators, candlesticks, Bollinger Bands, oscillators, etc. It is all very confusing, and takes an enormous amount of time and energy to learn.
I use simplistic technical analysis. I like stocks and the market who's highs are getting higher, and who's lows are getting higher. I like trends. Here are the two simple technical factors I like to look at and use frequently for readers of the OTC Journal:
The Support Line
Alongside is a chart of the NASDAQ Composite as measured from the March low when the current uptrend started. The Red line I have drawn in is the support line, which defines the uptrend.
Note that each and every time the market dropped back to that line, it bounced back up. I believe that until this line is solidly breached for several days, the uptrend is still intact. It is amazing how accurately Monday and Tuesday's drop took us right back to the trendline, which was followed by a rebound. This chart tells me the current uptrend is still intact until proven otherwise. This performance, coupled with projections of 20% operating earnings growth for the S&P 500 over the next year, has me convinced the Bear Market is over.
The 50% Retracement Rule
Here's another chart of the NASDAQ Composite with Support/Resistance lines drawn in. I believe this becomes useful when the short term trend line is broken to the downside.
The trendline I showed in the chart above will eventually be breached. There will be a short term trend reversal to the downside at some point in time. I don't know when it will be.
When it happens, I will be looking for the market to give back about 50% of its gains during the life of the trend. 50% is not an exact number, it is a range, which is why this chart has three lines in the middle. Those lines show the range.
Therefore, if the market were to break solidly below the trendline shown in the first chart, I would be looking for a pullback into the middle of the range, or a 50% retracement of the previous gains. If it were to start happening tomorrow, I would look for the NASDAQ to grind down into the 1520 range at which point you would have a low risk entry level. As long as the Bull Market remains intact, another uptrend would begin at some point in the future.
In my opinion, a break below the trendline shown in the first section would not mean the long term trend had reversed. It would simply mean the market was advancing into a long overdue corrective phase, and offer an opportunity to accumulate at reasonable prices.
If the market were to break solidly below the bottom line of the three in the middle, I would start to worry about the validity of this new Bear Market, and might take my money off the table until the smoke cleared.
The charts I have shown you can be drawn any way you want over any time frame, and can be applied to any stock. I believe you should look at longer term charts if you are looking to make longer term investments. For short term investments you should look at short term charts.
There are stocks I plan on owning for three days, and others for three years. Unless I get really lucky, I generally don't day trade. I've tried it, and I'm bad at it.
In the little universe of stocks I cover, you should pick out a few you really like. Instead of buying along with everyone else when there is news and the stock is hot, try accumulating when prices drop to trendlines or 50% retracements coupled by light volume. Sell a little when they trade well to get your cost basis down. If you become good at it, you could own a whole portfolio of microcaps with little or no cost basis. Also, as I learned the hard way from the Amgen story, don't be afraid to own stocks for the long term.
