Are Equities Still Cheap?

November 27, 2012


The most recent AAII Investor Sentiment Survey, which asks for investors’ opinions in the next six months, showed that 40.8% of investors were bearish on the outlook.  That is well above the long-term average of 30% and was only that low due to an eight-point decline from the previous week. There were 35.8% of investors in the bullish camp and 23.4% neutral on the market’s outlook.

Source: Schaeffer’s Investment Research

At current readings, the number of bearish investors is similar to August 2011 and May 2012, both periods just prior to an equity market rally.

The seasonality factor is also important.  Over the last decade, December has consistently been one of the strongest performing months of the year.  Returns in December averaged 1.25% during that time, the third-best month behind April and March. 


Source: Schaeffer’s Investment Research

Seasonality should also play a role looking towards 2013.  The website Decision Point recently highlighted work from the Trader’s Almanac showing that markets are seasonably unfavorable between May 1 and October 31.  From November 1 through April 30, though, markets generally trend higher.  The same phenomenon played out over the past 12 months. 


Over a longer horizon, price-earnings ratios suggest there is still plenty of room for equities to rally.  Bloomberg reported current P/E ratios are below the ending level for eight of the last nine bull markets.  In order for the S&P 500 to reach the average bull market P/E, the S&P would need to rally 26%.  If analysts’ earnings forecasts for 2013 are accurate, the S&P could see a more than 40% gain to reach the average P/E. 

Even though equity markets appear cheap by most valuation and technical standards, there continues to be a massive headwind from a macroeconomic standpoint.  Economists are concerned about the fiscal cliff, slower growth in China, and the tenuous situation in Europe.  Markets are already pricing in each of those concerns.  If we see small pieces of positive news begin to develop, it will represent a positive tailwind for markets entering the new year. 


the week ahead

Investors will be welcomed back from the holidays with a full slate of economic data.  More housing data comes in via the Case-Shiller Home Price Index and new home sales on Tuesday and Wednesday, respectively.  On Thursday, the second estimate of third quarter GDP is due out from the Bureau of Economic Analysis, with economists looking for a near-1% increase from the first estimate of 1.9%.   On Friday, the same agency puts out data on personal spending and incomes.

On Monday, a meeting of European officials is expected to result in a final agreement on the latest round of aid for Greece.  Barclays Research predicts the meeting will likely yield €44 billion in financing for the troubled country.

Several central banks are scheduled to meet this week, including Israel, Hungary, Brazil, Thailand, and Mexico.  Hungary and Thailand are expected to cut rates.