Would You Buy the S&P 500 at 25x Earnings??

Would You Buy the S&P 500 at 25x Earnings?
Certainly markets have seen booms in which the broad indexes sold at PE ratios in the mid-twenties and higher, but those were better times. In early 2007 when the S&P 500 was trading at 1400, analysts estimates for 2008 S&P earnings stood at $92. This created a relatively mild PE (price-to-earnings) ratio of around 15. By early 2008, earnings estimates for the S&P 500 had slipped to $72 while the S&P remained at around 1300, a ratio of about 18. At the end the third quarter 2008, analysts estimates for earnings had fallen all the way to $60 but the PE ratio remained at 18 as the S&P fell to nearly 1100.

But what about 2009 earnings?
Current analyst estimates for 2009 earnings for the S&P 500 have fallen to just $42!!! That is down almost 50% from what analysts predicted as recently of March of last year. So the future PE ratio for the S&P 500 at today's close of 935 is more than 22 and climbing!

In just the last 3 months analysts have slashed their predictions for 2009 earnings by more than 13%. In fact analyst estimates for 2009 have dropped by more than 13% in each of the last 3 quarters. If the first quarter of 2009 stays true to the pattern, look for estimates to drop below 36. At today's price this would represent a PE ratio of 26!

Don't expect a major sustained rally until expectations for earnings improve materially. And that may be a while.

Long-Short Strategies: Wells Fargo & JPMorgan

Looking for a long-short trade to put on to get some uncorellated returns and limit your market exposure? Here is the rationale.

Wells Fargo (WFC) is by far the strongest major US bank. It sells more products to each of its customers than other banks and has grown organically as well as through acquisitions. More importantly, it just acquired Wachovia which operates in markets Wells is already familiar with (unlike JP Morgan's purchase of Wamu). Wells has suffered no 11 figure write-downs like many of its peers.

JP Morgan (JPM) is also a strong US bank. However, JPMorgan will conceivably face more problems integrating Wamu than Wachovia, particularly with respect to California where JPMorgan has almost no experience. JPMorgan will remain a leader, but may find Wells Fargo is new leader.

Here is the real reason for the trade:
WFC Price (11.13 11.20am EST): 27.28
JPM Price (11.13 11:20 am EST: 35.04

Wells Fargo Market Cap: approx $91.5b (11/13)
JPMorgan Market Cap: approx $130b (11/13)

Wells P/E = 13.5
JP Morgan P/E= 16.1

Wells yield = 4.7%
JP Morgan yield =4.2%

Which one of these stocks is cheaper?
I think Wells is the better bank, but even if you believe they are even, JPMorgan looks to be about 10-15% overvalued relative to Wells. I don't know what the financial sector will do the next few months, but I'd put maybe 5% of a portfolio in this mostly market-neutral trade that could pay off 10 % or more in the next couple months. Will check back in a bit to see how this trade does.


Update: Since recommending the trade WFC is down to $20.91 from $27.28, JPM is down to $20.33 from $35.04. Wells the long part of our trade is down 23%, but JPM, the short portion of the trade is down 42.1% for a 19% gain on our market neutral financial trade.

Nikkei at Attractive Levels

The Nikkei 225 is now trading at just above 8,200. This represents a 55% discount to July '07 prices and almost 40% off of July '08 prices. The best way to play the Nikkei may be to buy a Japan ETF like iShare's (EWJ). Even if the Nikkei remains flat, you will make a profit if the yen continues to decline against the dollar, because you own actual Yen-valued assets, not just an index number. The real discount, of course, is compared with 1989 Nikkei prices. Almost 20 years ago the Nikkei traded at over 38,000 at the height of the Japanese bubble. Even if it took another 20 years to reach that lofty level, investors would make about 7% annually. Of course, Japan is better treated as a short to medium term play. With the Nikkei's fall steeper than the S&P 500 and the likelihood of further yen strength, the Nikkei may be in store for a quicker and more lofty rebound.

Dow Under 8300. Time to Buy?

With the down now approaching its 5 year lows, is now the time to buy stock? The answer is yes... and no. If you are short term market timing, today is a good day to raise your market exposure. We may not bounce off the lows, but if we do you could see 5% gains from today's price of $83 for DIA (with futures down almost 2% you may pick up DIA for $81 or $82 on Thurs). Sell if we hit 87 in the next 5 sessions (ending 11/19). If we go down further tomorrow, buy more DIA as low as $80.
Update: I thought this might be a week-long trade, but it actually materialized in one day. On Thurs, you could have bought for less than $82 (and I did) and then you would have hit your stop at $87 (it went on to $88, but you have to leave some profits). 6.5% one day trade. I must admit that this was much more luck than skill, but you have to take them when you get them.

If you are not a market timer, the best strategy is to dollar cost average with a twist. Pick a fixed portion of your cash to invest each week. I suggest 4%, but this number varies based on your time-frame. Unlike traditional dollar cost averaging, we will not blindly invest a fixed amount each week, but rather intelligently invest that fixed amount each week. Pick a day to invest (I like Tuesday). If the market is down on Tuesday more than 1% buy. If it is up wait until Wednesday. If Wednesday is down 1% or more invest this week's allotment now. Again, if Wednesday is also an up-day, wait until the next down day to invest. This method is dollar cost averaging on steroids. Since you are buying on down days only, you should pick up some extra yield from picking off the market noise.

Am I starting to finally sound like a bull? I hope not. I have been bearish for as long as I can remember, but at some point you have to be concerned about the upside if you are short. I now think the upside is far too big for shorts to do anything but sell off the highs of the session. No long term short trades are really safe.

Analysis of Short-Term Stock Trades

The only way to win the stock market game is to buy stocks when other people are selling and to sell stocks when other people are buying.

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The average returns per trade (in %) of this system's trading strategies"

Year Basic Strategy, Low Risk Strategy, Sell-Short Strategy, Combined Strategy
(Basic + Sell-Short)
2007 0.7 3.0 1.7
1.2
2006 0.6 1.6 0.8
0.7
2005 0.8 2.0 1.0
0.9
2004 0.5 1.2 0.7
0.6
2003 1.2 2.5 1.3
1.25
2002 0.5 0.6 1.6
1.05
2001 1.3 1.6 2.5
1.9
2000 2.6 3.7 6.1
4.35
1999 4.5 5.0 3.1
3.8
1998 1.4 2.7 3.6
2.5
1997 2.7 4.0 2.9 2.8
1996 3.3 4.8 2.2 2.75
Average 1.7 2.7 2.3
2.0
Stand. Dev. 1.3 1.4 1.5
1.2
Risk/Return 0.76 0.52 0.65 0.60

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