This week has been one of the stranger (and wilder) weeks in the stock market that I can remember.
Wednesday morning: pre-open, the talking heads on CNBC looked as if there would never ever be another up day in the market. Ever. The S&P 500 was ALREADY down 8% for the first 11 trading days of the year, the worst start to a calendar year in the history of the stock market. And the S&P 500 futures were deeply in the red.
As expected by the glum faces on CNBC, the S&P 500 opened trading in a free fall, and dropped from 1880 to 1812 around lunch time down 3.6% on the day, and 11.4% on the year.
But — stocks rallied sharply to close down “only” 20 SPX points on the day, around 1859.
Then: two days of solid gains (had to be some short covering going on), to finish the week at 1907, UP 27 SPX points on the week. (But, still down 6.7% year-to-date —- not great, but hardly the end of the world in the context of the rally from 666 on the SPX in early March, 2009 – almost a tripling in the value of the S&P 500 in not quite seven years).
In thinking about what it all means:
We anticipated a lot of volatility this year, and thought a range of 1700-2400 on the SPX was possible. By mid-day Wednesday, we had almost reached our downside estimate for the S&P 11 ½ trading days into the year.
At the lows on Wednesday, the SPX traded at 1812 / $125 consensus SPX earnings = P/E of ~14.5x. Given exceptionally low interest rates, a 14.5x P/E seems very inexpensive. It is not dirt cheap — like valuations were in 2009 — but for investors with time horizons of 3-5-7-10 years, 1800 on the SPX seems like a good place to allocate capital.
At today’s close of 1907, you’d be at 1907 / $125 = P/E of ~15.2x. Not as cheap, but hardly expensive; today’s valuation implies an earnings yield of ~7%, growing at (insert your best guess as to SPX earnings growth in coming years – 5%? 6%? 7%?). . . .throw in a 2% dividend, and that is a total return that is a lot better than the 10 year Treasury yield at 2%. The risk is: LOTS of day to day volatility. And . . . what if SPX earnings disappoint in 2016 because of slower than expected global economic conditions?
Therein lies the catch. More than at any time in the past decade or so, “aggregate” S&P 500 earnings are a little misleading, because different sectors are experiencing very different conditions. Energy earnings are down significantly; social media company earnings are growing rapidly.
And — valuations within the market vary widely as well: Amazon’s business is great, but understanding what it is really “worth” is difficult. Many industrials have seen stock prices come down a lot (Union Pacific!), but so has earnings growth, due to falling commodity prices, strong dollar, weak end demand, etc.
I think where this leaves us is this: investors with 1) a long time horizon, 2) a solid valuation discipline, and 3) some liquidity are in good shape. They can find places to invest at attractive valuations as opportunities to do so present themselves. Strong companies are still posting solid earnings results, except in the energy sector.
It is hard to say if Wednesday was a “capitulation” day. Only time will tell if it was. We continue to anticipate more volatility, and we’ll take things one day at a time, and be focused on exploiting opportunities created by periodic bouts of excessive market craziness. Owning companies with strong and profitable business models at attractive valuation levels should continue to be a very viable long-term investment approach; the interim stock price wildness is scary, and it makes things hard day-to-day, but sharp downside moves do create opportunities to add value for the long run.