10/22/12 – We Now Return to Our Regular Programming

Posted by Brad McMillan, CFA, CAIA, MAI

Find me on:

This entry was posted on Oct 22, 2012 9:08:30 AM

and tagged Yesterday's News

Leave a comment

All right, we did the optimism thing last week—now, back to the regular program. Not quite as bad as that, of course, but last Friday was the 25th anniversary of the 1987 crash, and that has focused minds a bit.

The anniversary of the crash hit the papers last Friday and over the weekend, with “Unhappy Anniversary, Dow” in the weekend Wall Street Journal (WSJ) followed by “That Old Sinking Feeling Returns, Circa October 1987” (p. B1 and p. B5, respectively). These articles were supported by “It’s Time to Time the Market” (WSJ, p. B7), which is about how the market is priced at a level that historically has produced disappointing returns going forward. I will note that my own research, as well as that of many others, also supports the conclusions of that article. The New York Times (NYT) didn’t explicitly headline the crash, but it did put “Shares Fall as Earnings Disappoint on Wall St.” on B1, the front business page.

There are reasons to be cautious about the stock market. Although I believe the U.S. economy is healing, as I have said, the fact is that business has done much better than the average consumer so far in this recovery, and profit margins and market price levels reflect this. Corporate earnings have risen for three years running, and, on average, they have tended to run for three to four years before hitting a decline. This quarter is showing decreases in top-line revenue, per the front-page headline in the weekend WSJ, “Falling Revenue Dings Stocks,” and unless margins expand from current record-high levels, a decrease in earnings seems likely. Based on current P/Es for multiple time scales, which are above average levels, that is not what the market is expecting.

The past month has seen some choppy trading, as the market has jumped up and fallen back three times so far. Just as the market decoupled from the consumer economy on the way up, it is entirely possible for it to decouple on the way down, tanking even as the real economy continues to heal. Larger companies, which constitute most of the market capitalization, are typically exposed to the global economy in a direct way that the consumer is not, and slowing economies elsewhere can therefore be another drag on earnings.

The consumer continues to do his or her part. Housing resales were down a bit month-on-month, at least partially due to a shortage of supply—which is a positive for future price gains—but were still up year-on-year for the 15th month in a row. As an aside, it is interesting to compare the weekend headlines—“Home Resales Retreat From a 2-Year High” in the NYT and “Home Sales Rise for 15th Month” from the WSJ. Both are accurate but send very different messages. The WSJ also followed up on the healing real economy on Monday, with “Economy Seems on the Mend, Poll Finds” (p. A4) and “The Once Mighty US Consumer Awakens” (p. C10).

Overall, the baton may be shifting from business to the consumer as a growth leader. While this will be good for the real economy, because the consumer makes up approximately two-thirds of all demand, it may not be so good for equity markets. With concerns about earnings rising, and with valuations at high levels—not to mention the fact that it is October—a degree of caution in the stock market seems appropriate.

Upcoming Appearances

Tune into Fox Business' Countdown to the Closing Bell on Friday, July 12, at 3:45 P.M. ET to hear Brad talk about the market. Check your local listings for availability.

Subscribe via E-mail

Crash-Test Investing
Commonwealth Independent Advisor

Hot Topics

Have a Question?

New Call-to-action

Conversations

Subscribe

Disclosure

The information on this website is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Please contact your financial professional for more information specific to your situation.

Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets.

The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. All indices are unmanaged and investors cannot invest directly into an index.

The MSCI EAFE Index (Europe, Australasia, Far East) is a free float‐adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada. The MSCI EAFE Index consists of 21 developed market country indices.  

Third party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided at these websites. Information on such sites, including third party links contained within, should not be construed as an endorsement or adoption by Commonwealth of any kind. You should consult with a financial advisor regarding your specific situation.

Member FINRASIPC

Please review our Terms of Use

Commonwealth Financial Network®