No offense to them, but the bears are running out of excuses. Worse than that, the effort to pound the bearish table might be distracting them from some stunningly undervalued stocks that are bargain-priced — no matter what the market’s near-term destiny is.
We’ll look at those bargains, but first, let’s set the tone with a market valuation reality check.
The Arguments Are Falling By the Wayside
First, it was the assumption that the U.S. economy would be in a depression for years … perhaps forever. But by 2010, that 2008 assumption had been trumped.
Then, the pessimists argued that earnings growth wasn’t real growth, but accounting trickery. But after 11 consecutive quarters of sequential as well as year-over-year earnings growth (Q4 2011 is expected to be down), it’s tough to chalk up record levels of income as circumstantial.
Most recently, the naysayers are arguing that the market’s ultra-low trailing P/E ratio of 13.3 isn’t a reason to buy, since the P/E ratio doesn’t really matter.
Really? Since when does the P/E not matter?
The argument is as follows: Low P/E readings don’t inherently make stocks go up, and high P/E measures don’t inherently make stocks go down. Take the late 1990s. The S&P 500’s P/E moved from a tolerable 14.8 to a disturbingly high 29.6 by the middle of 1999, yet the market was rallying the whole time. Conversely, a multiyear-low P/E of 13.8 in the middle of 2008 didn’t stave off even more of a pullback for the broad market then. Fair enough, but time still managed to catch up with the market in both cases. The end of 1999 was the beginning of disaster, and the end of 2008 was the beginning of a recovery.
Point being, while a P/E ratio isn’t a laser-price timing tool, there is a measurable correlation between stocks and the market’s value. And yes, there is a semi-quantifiable “too high” and “too low” for the market’s P/E level. But there’s another aspect that needs to be added to the mix — the direction of the earnings trend at the time.
The Other Important Aspect
Click to EnlargeIt’s stupidly simple and painfully obvious, but it’s still overlooked. When earnings are rising, so is the market. When earnings are falling, so is the market. This was why the market tumbled in 2008 despite a low P/E reading — earnings were falling. And this is why stocks continued to soar in 1999 despite an already lofty valuation — earnings were on the rise.
See the difference? It’s the combination of the earnings trend and the P/E levels (along with some common sense) — and not just a P/E ratio alone — that allows investors to make an informed judgment call on the foreseeable future for stocks.
Fast-forward to today. Earnings are on the rise and reasonably expected to keep rising through 2012 — and the market is as undervalued as it has been since the late ’80s.
Now, about those crazy stock bargains …