Equities – Riding the rescue wave but don’t flip over on the surfboard – it hurts……..

Nikkei 225 (8.665)  Topix (847)  Dax (4.729)  FTSE 100 (4.226) Dow Jones (8.630)  S&P 500 (880) Nasdaq Comp (1.540)  

S&P 500 is trading at an expected P/E of around 10, based on the latest average of economists forecasting the S&P 500 earning next year to be $91.

A P/E at 10 is not aggressive either way given the very difficult macro-and micro economic conditions against historical higher P/E values. So will it go up or down from here?

As mentioned a couple of times before it will be a bet about, in particular, when the investor thinks that the recession is over. Right now there is no doubt that the environment is positive and it has been so for some weeks now. Stock markets trades slightly higher while more and more are talking about new lows – that should always make us alert. It normally smells of people who didn’t see the trend turning, but this time the downturn is so severe that nothing is like normally. So despite the current positive environment I stay in the sceptical camp as the macro economic clouds are getting darker and bigger.

What is behind the positive sentiment?

The rescue packages overshadow everything, but it must be a matter of trust to believe that moving debt around can rescue anything in the world. Fiscal stimulus will help short term, but in US is the bill that needs to be repaid mounting. Fundamentally I am very reluctant to go fundamental long equities on this story.

Surely hedge funds are not forced to reduce equity holdings with the same pace as before. Not that they are buying in the market, but just that a big selling source is quiet helps the market.

At the same time I have the feeling that private investors are back in the market buying typical value stocks. There has always been a tendency that private investors come out of the market too late or come in the market too early. I hear too much of people buying local well known classical value stocks at prices they haven’t seen for long, where the reason to buy is the actual “low” price. Only problem is, it might not be cheap – most likely not.

In Far East the Chinese Government does everything to keep up the stock market, in what I call intervention. Very possible some of the same is going on in Japan where one fund has showed interest to buy (explained a couple of times the last 2 months). All in all it helps to stabilise, or maybe even turn, the market for a period.

Day traders or short term traders have understood that rescue packages equals bullish markets where the negative news send stocks lower. One very simply could say, that due to more good than bad rescue package news the last 2 weeks short term traders have pushed equities higher.

There is speculation about the settlements in US equities on Friday 19^th December. Some claim that market participants have closed short positions due to rising prices. Maybe, but in that case it should be settled and I don’t think that these currently closed shorts will be reopened again.

It’s all just assumptions or market feelings, but all in all is my opinion that the current uptrend mainly is based on private investors buying into a dropping market, some state interventions in parts of the world and short term players riding on the rescue package wave. In my world are none of these reasons truly substantial buying reasons. That would be fundamental long term buyers like pension funds, asset managers coming back to the market, good macro economic news and/or company earnings that start to point upwards.

It leads me back to the expected S&P 500 P/E for next year. No trading cycle is like prior cycles but there is a pattern. During the last recessions economists have overshot S&P 500 earnings with about 1/3. If one thinks that a P/E value at 10 in S&P 500 is fair during uncertain times and economists once more overshoot earnings with 1/3 meaning $60 instead of $91 for 2009, then S&P 500 should trade towards 600…….

Targets: Nikkei 225 6.683  Topix 697  DAX 3.906  FTSE 100 3.456  Dow Jones (6185)  S&P 500 (656) Nasdaq Comp (1191)

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