You never actually know when it’s time to start buying stocks after a market drop, but let me give you a few “quantitative” hints.
The average forward P/E ratio for Sabrient’s top-ranked 100 stocks is normally between 7.5 and 8. At the 2011 market top on May 2, the average forward P/E for those stocks was 8.7. After Monday’s close, the average forward P/E is about 6.3.
Looking at it a different way, the market is down 22.5% from the May 2nd high through Monday’s close, but earnings forecasts have increased for the top-ranked 100 stocks. That makes the discount of the forward P/E nearly 30% lower than it was at the market top.
Let me pass along another interesting statistic. Sabrient produces an indicator that shows us how much we have to pay for the expected absolute quarter-over-quarter earnings for each stock. That number has nearly doubled since May for the top-ranked 100 companies. In other words, how much growth can I get for a buck? Almost get twice as much as I could get on May 2.
We’re talking undervalued versus overvalued. In May, when the average forward P/E was 8.7, we were quite choosey with our stock picks because the whole market was a tad pricey. Today, the S&P 500 Index is not that far from the February 2009 bottoms when the average forward P/E of our 100 top-ranked stocks was slightly over 5. In that issue, we called it an “historic buying opportunity” — which it was.
Clearly, the current market could drop yet another 20% before it reaches support. So we’re not yet at an historic buying opportunity, but perhaps it’s time to start nibbling. (See stock ideas below).
Hedging your bets. You could also hedge against volatility with the VXX, the S&P 500 VIX Short-Term Futures ETN which measures volatility in the market. (It’s also called the “fear index.”) The VXX has risen dramatically in the past two weeks, but it’s far from historic highs. In February 2009, at the market bottom, VXX had had reached a high of 450. By April 2010 it had fallen to 75. Within a month it climbed back to 145, then slowly drifted all the way to 20 in July 2011.
Today, the VXX is 35, so clearly, it is not too late to consider hedging forward volatility with VXX itself or call options on the VXX.
Speaking of historic events, S&P’s downgrade of the U.S. sovereign-debt rating on Friday was the first ever, which puts us below Germany, France, the U.K, and a few other countries. The U.S still may be the most liquid and safest sovereign investment, but the downgrade, at minimum, has cast doubt on that certainty. The downgrade could also affect interest rates in a modest way. Indeed, if our record-high national debt were to become more expensive, that could be disastrous for our ability to work our way out of this situation.
The real problem, as S&P pointed out, is that we seem to have lost the political capability to solve our economic problems, as demonstrated by the bill that finally passed Congress last week. They applied the tiniest of Band-Aids to control our spiraling national debt when a tourniquet was needed.
Hopefully, the S&P downgrade will be a shot across the bow that forces Congress to react more capably to address our real problems. Otherwise, we can look forward to joining the PIIGS of Europe (Portugal, Italy, Ireland, Greece, and Spain).
But who exactly will bail US out?
Last week in review. The best performing cap/style last week — if anything last week could be called “best performing” — was Large-cap Growth, down -7.5%. It barely beat Large-cap Value, which was down -7.7%. But aside from large caps, value outperformed growth in small- and mid-caps. The very worst performer was Small-cap Growth, down -11.1%.
The best sectors, as you might expect, were Consumer Non-durables at the top, followed by Utilities and, somewhat surprising, Technology, in third place — probably because of the performance of large-cap growth stocks. It’s not a surprise that Basic Industries and Energy finished last, which is almost always the case when economic growth is in question.
Our forward looking SectorCast is somewhat slow to react, so Friday’s downgrade and Monday’s market results are not factored in. You can view the SectorCast with the market stats, but I wouldn’t put much confidence in the rankings until we see what this week brings.
Economic reports. Last week’s economic numbers certainly haven’t helped. The very weak ISM Manufacturing Index last Monday was followed by a lower-than-expected number from non-manufacturing index report. Personal income and spending, and construction spending were also disappointing. We got a tiny boost from the ADP report, with a 0.10% drop in the unemployment rate (from 9.2% to 9.1%) and a miniscule improvement in new jobless claims.
Corporate news won’t be of much help this week, as 80% of companies have already reported. Nor will economic reports have much chance of moving the market or breaking its fall.
Could some pronouncement by the G7 or the G20 or the European Union or Japan or China or maybe our own Fed help us out? Maybe. But I wouldn’t bet on it.
That said, I think there are true bargains after this market drop. Much of corporate American is still very liquid with outstanding growth prospects, so we should fill our portfolios with those stocks. If you’re comfortable with hedging, try the VXX or an inverse market ETF to protect your portfolio as best you can.
It seems to me that it’s too late to turn to gold, although clearly there are other alternatives. The points I made at the beginning of this piece described an “undervalued stock strategy,” but there are other strategies, one of which is “rock-solid yields” (the high-yield, large-cap “safe” companies).
4 Stock Ideas for this Market
This week, I started with the Undervalued Large Cap Growth preset search in MyStockFinder. I also included Buys (in addition to Strong Buys), as well as Mid caps and Small Caps, and I slightly up-weighted Technicals. I then cross-referenced the candidate list with a list of those stocks with the lowest forward P/E and projected growth. Here are four stock ideas that look intriguing, particularly if this challenging market can find support: