Equities – A story about P/E ratios.

Nikkei 225 (7.969)  Topix (779)  Dax (4.635)  FTSE 100 (4.284) Dow Jones (8.281)  S&P 500 (869) Nasdaq Comp (1.592)  

In early October 2007 the S & P 500 was trading at 17,0/17,5. About one month later in mid November the level was at 16,5/17,0, a bit lower after the October high in the stock market. Despite clear signs of a slower US economy, investors also in November 2007 believed in “the sky is the limit”. I surely remember it, as I was bearish on the world already then (what a surprise) and was about to think that I had made a mistake of the century by not owing any stocks.  

Last week the small quality equity research house Bernstein lowered their total S & P 500 earning forecast for 2009 from $66,10 to $58,10. Using the Friday S & P 500 close at 869 it results in an expected P/E ratio of 15 for 2009.

Now, you might start to figure my point out J

I would never argue just to look at P/E, or say that S & P 500 is the whole world nor might the research forecast be right. But P/E ratio’s can be an interesting piece of information and S & P 500 is after all a leading stock index. The forecast off course fits my opinion, but I still argue that there is quality behind the forecast.

My thinking is very simple. In the autumn 2007 the world was running for full speed with high expectations to corporate profits. Even growing corporate earnings were priced in the market. In the meantime the global economy is in the worst crisis since 1930 some say (I would argue since 1982 – 1983, but it will soon be worse than the early 80’s). Corporate profit deteriorates at a pace we haven’t seen long, the US housing market continues down, countries within the Euro Zone might default, Central and Eastern Europe is heading towards yearly negative growth rates of 10%, Far East suffers in general from bad to worse.

The global economy will not V shape rebound but L shape meaning we won’t see a jump in corporate earnings later this year. It’s most likely that the results this year will be repeated in 2010 because the world totally is gearing down in activity.

Added all this global macro economic and corporate earnings turmoil together, I ask myself if it makes sense that the P/E just goes down from 17 to 15? You know my answer, it’s no.

Last week Dow Jones found support below the 7950 area again (S&P 500 around 810), and I respect that right now is the investor world betting on the US stimulus package once more. All in all giving wind to the large bull fraction in the market (those who beat the benchmark last year by only losing 40%……). This fraction certainly is looking forward…..One day it works of course, but we haven’t found true economic foothold yet. I continue to argue that the P/E ratio needs to be lower with the current risk scenario.

Ok, back to the tactical decisions. Last week equities were bid, but Japan didn’t really perform. Investors in Japanese stocks have within the last year been very realistic despite Japan would benefit relative more from a Chinese rebound than other old large economies. Either, Japan will go up this week or the world will correct lower – I go for the last one. The Japanese machinery orders form this Monday surely didn’t support a rebound in Japan.

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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