The first time I thought about the P/E Decompression Stampede scenario was on October 12, 2011. We were at S&P 1198 intraday, right around my favorite pivot point of 1190. I reread this article today, and quite frankly, there is nothing much to add. Earnings have come through, Europe is working out its problems, the U.S. economy may be perking up, the political scene in the U.S. is not clearer, and the deficit is getting bigger. Mix it all up, there is no real reason for stocks to be up 12% since then. Except for liquidity.
Liquidity is a very subjective notion. When stocks go down, one is never liquid enough. When stocks go up, one is always too liquid. I measure it several ways, from macro to micro, but as far as stocks are concerned, my best test has always been price reaction to the news, usually earnings. Whatever the news is, if stocks exhibit an overall tendency to either go up or down, I'll infer the market is either liquid or not for this particular asset class.
There have been many stocks going up 10% on earnings this quarter - United Rentals (URI), Cintas (CTAS), Wesco (WCC), Sanmina (SANM), to name a few of my favorites. And if this is not enough, just look at Microsoft (MSFT), Apple (AAPL), and Exxon Mobil (XOM): In a couple of months, their cumulative market cap increase is some $150 billion. That's liquidity.
Which makes it extremely difficult to stay the course. The stock is up 10%, the market is flat, there is no news really, sell the stock! Well, usually, this is the right move. However, let me reflect on some recent history. From the 2009 March lows: Ion Geophysical (IO) is up 8 times; United Rentals up 12 times; Farmer Mac (AGM) up 7 times; Sanmina up 11 times; and so forth. Selling these stocks after a 10% move left you real sorry.
The bad news: The bottom is behind us. The good news: Don't get impressed by the moves off the bottom. Focus on valuation, and on P/Es that have room to expand. For the record, we are at S&P 1350, 2/8/2012 pm.
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