The key fundamentals all turned positive at the end of 2008. That indicates an "easy money" bull
was set to begin -- easy because of a strongly supportive monetary policy, and easy because of a
very positive return for risk profile. These indicators posit that the easy money bull ends when all
turn negative and not until then. In recent months, the indicator set has been running around 50%
positive and 50% negative.
But the core indicators, unlike any other period since the end of WW2, have not shielded investors
from steep corrections in both 2010 and this year. This new vulnerability reflects both the very
slow recovery of private sector credit and a continuing weak labor market despite a surge in
corporate profits as business has pushed very hard for profit margin gain via rigorous control of
payrolls, including both new hires and wage costs. Without normal private sector credit creation
and with a weak picture for household incomes, investors have been trimming the market's p/e
ratio despite the sizable gains in business productivity and profit margins.
SP 500 Market Tracker
Based on strong earnings growth and a moderate inflation level, the Tracker posits a p/e of 16.5x.
With SP 500 net per share now running at a $100 annual rate the SP 500 should be trading at 1650
as opposed to the current level of only 1252. The discount of 24.2% to Tracker value is highly
unusual and reflects investor concern that the US economic expansion is not secure and could be
vulnerable to recession and the resumption of deflation pressure. Players know that an economy
with such a slight recovery in private sector credit could suffer a relapse without strong growth
of monetary liquidity. The US has experienced a large bulk up of monetary liquidity, but investor
confidence has wained each time the Fed stopped adding such liquidity since it began its quantity
easing programs in late 2008. Investors also worry that robust profits bought in no small measure
through a weak labor market are suspect under such conditions. It is also very important to note
that weakness in the weekly leading economic indicators have developed each time after the Fed has gone on record that it was paring a program of quantitative easing. Finally, the Eurozone could well
have entered an economic downturn which would affect SP 500 profits directly and through knock
The Here And Now
There is adequate monetary liquidity in the system to fund further economic expansion and
the credit markets continue their thaw. However, if the labor market does not firm up appreciably
as the months wear on, the sustainabiltiy of economic progression will become increasingly
suspect. and the market's p/e ratio is likely to erode further even if earnings progress. For now
then, there is not much to do but keep an eye on the economic indicators.
The market's deep discount to the SP 500 Tracker suggests powerful upside provided the
economy yields a stronger labor market and more confidence and willingness to use credit by
There are several other fundamental issues to tackle in subsequent posts this week.
- Peter Richardson
- Retired chief investment officer and former NYSE firm partner with 50 plus years experience in field as analyst / economist, portfolio manager / trader, and CIO who has superb track record with multi $billion equities and fixed income portfolios. Advanced degrees, CFA. Having done much professional writing as a young guy, I now have a cryptic style. 40 years down on and around The Street confirms: CAVEAT EMPTOR IN SPADES !!!