The equity markets were nervous today about the Federal Reserve Chairman’s testimony that the economy’s outlook is “uncertain”. Most indexes sold off more than 1% after gapping up in the morning.
While the effect of Bernanke is the reason most cited for today’s sell off, a technical explanation would be that since topping in April, equities have been in a downtrend. Today’s gap up simply brought price in line with the downtrend line and contained it. On the chart below, this is the downtrend channel (blue lines) with lower lows and lower highs that I’ve been harping on lately:
The other interesting aspect of the chart is that basically stock prices has been chopping around for the past 9 months. The red horizontal line is the short term top formed on September 16th 2009 when the S&P 500 reached 1068.76 - this was also a very rare occurrence: a 20% move above the 200 simple moving average.
To be fair, the S&P 500 did eventually climb about 14% higher until April 2010 but it then gave back everything and ended up right back down at the September level.
At the start of the month, before the latest rally, the S&P 500 was 8% below its long term moving average. Right now it is just under it (less than 3%).
For the most part, earnings, that have been very good over all, have been ignored. According to John Butters at Thomson Reuters, “With 100 S&P 500 companies reporting to date, 76% have reported earnings above estimates and 65% have reported revenue above estimates”.
Generally speaking, earnings do not really matter. This is because at different times, each dollar of earnings is worth a different amount to investors. At times, it is worth very little and at other times, the same dollar of earnings is bought at astronomical multiples.
But for what it’s worth, US companies are generally reporting positive earnings with strong balance sheets. As we already discussed, there is a huge pile of cash waiting to be spent.
According to Shiller’s CAPE method of calculating the P/E ratio, investors are paying an estimated $20 for every $1 of earnings. From a historical perspective, this isn’t very “cheap”. Think of it this way, 77% of the time the market has had a lower P/E ratio.
Stock Charts vs. Spreadsheets
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