an tSionna {04.09.12}

We showed you this chart of the S&P 500 last week, noting that the market needed to find support at this purple trend line.  That's exactly what the market did, recovering from sell offs both Friday and today.  Under the hood though things are not looking so good.  Market breadth has been deteriorating for about a month.  The percentage of stocks trading above their 200 day and 40 day moving averages is still elevated but has been declining during the same time period.  Basically we have a market where trading in the indices is masking some real deterioration in stock prices.  Sectors that have been out performing recently, consumer staples and utilities are usually not the stuff of market advances.

The other side of the coin is that valuation numbers by our work are still reasonable.  Josh Brown over at the Reformed Broker.com notes via Brian Gilmartin over at Trinity Asset Management, that four quarter forward looking earnings estimates for the S&P 500 are $115.25.  Both Josh and Brian noted yesterday that assuming these estimates hold then stocks are trading with a 13.5 forward PE and a 7.42% earnings yield.

I think that number's a bit high and am carrying a forward year's estimate of $109.40.  Still my number  if it is correct gets you a PE of 14.30 and an earnings yield of 7.0%.  Using a 15 PE that would imply  an S&P trading around 1,650, about 6.0% higher than where we trade right now.  Again that's on my estimates not theirs.  If their number is correct {I'm assuming it's from someplace like Factset} then stocks have the potential to trade much higher than my estimates.

Stocks have been jumpy and all over the board in up and down trading for the past month.  There is a real push/pull between earnings growth expectations and evidence that the economy may have slowed a bit recently.  First quarter earnings season is starting now and it strikes me that stocks, perhaps more so than in recent quarters, will resolve themselves one way or the other based on the forward guidance companies throw out.  Not as much room for error right now in either the valuation or the expectations department.  We're going to start seeing some clarity here in the next 10 trading days.  What companies say now will likely set the table between now and the fall.

*Long ETFs related to the S&P 500 in client and personal accounts.

Reformed Broker.com:  Forward Earnings Estimates Set a New Record High

Gilmartin/Fundametalis.com: Forward Earnings