When I look back on the suddenness and violence of the recent price decline, I still do not see the
sharp outlines of an oncoming iceberg that made the other guys jump ship. Naturally, the history
of the market is littered with price corrections, and Lord knows, one was perhaps long overdue.
However, I still think the guys jumped ship too early.
The correction has greatly widened the playing field as seen on this daily rendition of the SPX
The market is currently challenging the steep downtrend in place, but with the employment report
and a three day weekend just ahead, players could wait for the unofficial end- of-summer return
of the heavy hitters next week from holiday. Given the new broader range for the market, an
elevated VIX (bottom panel of the chart) seems appropriate.
The basic market directional fundamentals I use to judge the market are still intact in favor of a
rising SPX although liquidity growth is far less robust. On that score, I ended my low risk
view of the market in the closing months of 2014. At the SPX high of 2135 set earlier this year,
the market traded about 19.5x 12 months net per share. That is an elevated level by any sensible
long term measure. However, although a p/e ratio has substantial empirical content, it is also
heavily influenced by investor confidence. Because of this psychological element, it is very hard
to use valuation successfully to time the market. And so, in this case the market received a quick
p/e haircut on rapidly waning confidence (I hope that players do not go for a buzz cut and bring
the market below crucial support in the low 1860s on the SPX).
I do use a valuation measure based on long term trend earnings and I give heavy weight in estimating
a 'fair value' p/e level based on a long term measure of the earnings plow back ratio (Higher plow
back implies faster longer term earnings growth and a higher p/e multiple). Long run trend earnings
for 2016 stand at SPX $117 a share, and my fair value p/e based on a 60% plow back ratio is 17x.
So I see the SPX as reasonable at about 1990. Note too, that the previous high of 2135 did not
represent a significant overvalued level with my approach).
There is fear in the market and with guys like me, there is quizzicality. In turn, my indicators show
an impressive oversold condition is also in place. We will just have to see how it all plays out.
- 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 !!!