The last couple of weeks a common theme is in the headlines. Debt. I find it interesting how this is now becoming an issue again. It never really stopped being an issue it was just put on the back burner while the markets were focused on what all the debt money went to for stimulus. Now the markets are stepping back and asking the same question I asked last fall – is it sustainable. Not the debt, but the growth from the spending. The resounding answer so far – NO! Look at the housing data yesterday when buyers thought the tax credit would expire they were down 17% from November. The point is simple, markets are ahead of economic growth. This is bad news for investors as we look to the balance of 2010.
Sorry to say I am a skeptical market participant. I am no one to fight the trend, but I am also not beating a drum that everything is okay in the economy. I have read report after report stating the markets will growth 10%, 12% and even 20% this year. It may very well do so, but it is not likely to be in a straight line and volatility will play a much bigger role. My outlook currently is not so bright and is more in the 6-8% range. Why? What you are reading in the headlines, DEBT. It is a bigger problem than we want to accept and one that is strangling the economic recovery. I am not interested in depressing you, however knowing where the potholes are in the road may make the ride smoother.
Thus, stay focused on managing your money. We have raised plenty of cash the last couple of weeks. Not out of fear or because of debt levels, because we have hit our stops based on the downside risk we were willing to take. We never stop looking for the opportunities to make money regardless of direction. The downside plays are setting up short term. Now is when we have to be patient and let the plays develop.
One fundamental data point I have been watching is the P/E ratio of the S&P 500 index which now stands at approximately 20 times earnings. Historically 14 times earnings is consider fair value or on the cheap side. Even if we use 16 times earnings the market on a fundamental basis is overvalued. I know some will disagree and say looking forward the numbers are more in line. Looking forward we are assuming growth. Yes, it could pan out in the spring as the roses bloom, but we have to plan based on what we know and guard our assets against risk. From my view the valuations for the market are high. I believe that is the underlying issue facing investors currently. We can use debt as the scape goat for the adjustment to value (stock prices declining), but the valuation will have to be in line with future expectations in order for stock prices to rise.
Two key points to watch on the broad level, first the S&P 500 index support at 1085 and second, the NASDAQ support at 2205. Break these levels with conviction we step lower to the next level of support. The first levels of support, from my view are critical short term to the sentiment of investors. While I didn’t think we would get to this decision point this quickly, we are here. You still have to let this play out. This is not time to panic, it is time to plan according to the risk you are willing to accept and make the necessary adjustments near term. The planning is for your psychological well being as much as logical.
Stay focused on your goals, manage the risk of your money and look for the opportunities.
Disclosure: no positions