Markets Neither Here Nor There

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Includes: BBBY, BBY
by: Greg Feirman

Does ripe fruit never fall? Or do the boughs

Hang always heavy in that perfect sky?

- Wallace Stevens “Sunday Morning”, quoted in “Green Shoots, Weak Roots”, John Hussman, Weekly Market Comment, January 11, 2010

The test of a first rate intelligence is the ability to hold two opposing ideas in mind at the same time and still retain the ability to function.

- F. Scott Fitzgerald

As fourth quarter earnings get under way, I feel my attitude towards the market in a state of limbo.

The fundamental fact is the relentless rally. Regardless of the economy or fundamentals, the market continues to trudge higher. That fact weighs on me and cannot be ignored.

Also, there are signs of real improvement here and there.

After five straight quarter of negative same store sales, Bed, Bath & Beyond (NASDAQ:BBBY), the $11 billion goliath home furnishings retailer, reported a 7.3% same store sales increase for the quarter ended November 28, 2009. Coming after last year’s comparable quarter 5.6% decline, that only gets us back to slightly above the peak from the quarter ended November 28, 2007. Still, that’s not a bad place to be given all that’s transpired.

Along the same lines, on Friday Best Buy (NYSE:BBY) reported a 9.3% increase in December same store sales. That’s a big, impressive number though, again, last December was a disaster and so it’s compared to a low base.

On the other hand, both of these stocks have had huge runs and are no longer fundamentally cheap. Best Buy is up 60% from its March low and trades at 13.5 times the last four quarters net income. Bed, Bath & Beyond is up about 100% over the same time period and trades for 17.5 times current year earnings.

Though business is clearly improving for both of these retailers, are either of them really buys after the runs they’ve had and at these valuations????? I personally can’t stomach buying them here.

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bespoke-4q09-sector-earnings-growth-estimates

(Source: BeSpoke Investment Group)

Optimism also runs high for the upcoming 4th quarter earnings season. S&P 500 operating earnings are estimated to be $15.80, up from $5.62 last year. Revenues are also forecast to increase year over year and sequentially.

Expectations are particularly high for the all important financial and technology sectors. Financials earnings are forecast to be up 120% and technology 30% compared to the year ago period. Earnings for six of the ten S&P sectors are actually forecast to be down year over year. Consumer Discretionary earnings are forecast to be up 8% (Chart Attached). Therefore, much of the strength of the current earnings season rests in the hands of those two key sectors.

Even if the quarter comes in in line, that would put full year 2009 operating earnings at $60 a share. At today’s close of 1136, that represents a 19 trailing multiple. Not cheap. After all, the entire S&P 500 has itself rallied 70% from its March lows. Is now the time to jump in? Are stocks broadly a compelling buy after this run and at these levels of valuation? It is hard for me to accept that they are.

Hence, I find myself in a state of limbo, not wanting to fight this market anymore but also not having the stomach for buying in here: Does ripe fruit never fall? Or do the boughs hang always heavy in that perfect sky?

Full Year 2009 Performance

S&P: +23.45%

DJ Total: +26.52%

Top Gun: +6.36%

Since Inception Performance (Jan 1, 2007 - Dec 31, 2009)

S&P: -21.38%

DJ Total: -19.12%

Top Gun: +39.96%