Against the still very poor economic macro backdrop, one has to look at the valuations that stocks currently have. Those, to me, look wildly attractive, particularly if the current earnings expectations (or anything close to them) can be achieved. If it turns out that we avoid an outright double-dip recession — and the decline in profits that usually comes with one — then the market should rally from here.
Expectations are starting to come down, particularly for 2012, but the vast majority of stocks in every economic sector is expected to earn more in 2012 than in 2011. Those are not my forecasts, or even Zacks forecasts — they are the collected wisdom of the individual analysts who cover the individual stocks in the S&P 500.
From my big picture point of view, it is hard to see how those forecasts won’t come down. However, there is still a fair amount of room to work with. The total earnings for the S&P 500 are currently expected to be 13.0% above 2011 levels next year. Some of that growth is due to the assumption of few write-offs at the banks. The timing of those can be hard to forecast, but I’m not sure it is a good assumption that the write-offs will fall dramatically.
However, even excluding the Financial sector, 9.8% growth is now expected for 2012. We have started to see some estimates fall, but it has been happening at a very seasonally slow time for estimate revisions. Still, when you see more than three times as many estimate cuts than increases for next year, it is time to get a bit nervous.
On the other hand, even if growth were to come all the way down to 0%, the market would still be trading at just 12.7x earnings. That is not exactly a nose bleed level, especially when long-term interest rates are extraordinarily low.
Dr. Copper Also Staged a Rebound
The rebound in stock prices has been confirmed by a rebound in copper prices, I found the decline in copper prices a few weeks ago particularly alarming. However, they have since bounced back to $3.42 from a low of $3.10 two weeks ago, a rise of 10.3%. Copper is sometimes referred to as the metal with a Ph.D. in economics.
While the increase over the last two weeks is reassuring, it has to be seen in the context of being off from a record high of $4.55 back in February. The good doctor is pretty much screaming about a coming economic slowdown, not just here, but around the world.
Valuations Remain Attractive
Long-term investors should start to take advantage of current valuations. However, I would not be shooting for the stars. Look for those companies with solid dividends (say, over 2.5%), low payout ratios, solid balance sheets, and a history of rising dividends, which are still seeing analysts raise their estimates for 2012, or are at least not cutting them aggressively. I don’t know if you will be happy putting your money here next week or even next month, but I am pretty sure that you will be quite satisfied five years from now if you do so.
Not All Decades Are the Same
People tend to extrapolate the results of the previous decade or so when looking at what to expect from the stock market, and that is almost always a mistake. It led most people to be excessively bullish around 2000, and extremely bearish in the early 1980’s.
The analysts who track the individual companies are still looking for solid growth in earnings next year, so unless we see the current trend towards cutting estimates continue or even accelerate, it is unlikely that the gap gets closed through falling earnings alone. It might well be a better case against investing in long-term government bonds than it is in making the case for investing in stocks. From the point of view of the long term investor, this still looks like one of the best times to invest in my lifetime.
Where to Look for Good Buys
I would be very cautious about investing in the Financials, particularly the "too big to fail" banks, both here and in Europe. There are lots of other attractive-looking stocks that are worthy of your attention. Look for stocks with solid dividends and strong balance sheets, ones that will be able to withstand a temporary slowdown in the economy. Ideally, look for stocks that also are rated either #1 (Strong Buy) or #2 (Buy) based on the Zacks Rank. These can be found in many different parts of the economy.
For example, right now DuPont (DD), Deere (DE), Genuine Parts (GPC) and Norfolk Southern (NSC) all meet the criteria.
While I prefer dividend paying stocks, one to consider strongly before its earnings announcement this week is Apple (AAPL). Its latest iPhone has been extremely well received, selling over 1 million in its first day. It also seems to be the most likely beneficiary of Research in Motion’s (RIMM) reliability problems.
Apple could certainly pay a dividend if they chose to given its massive cash hoard and ample free cash flow. Other big-cap techs like Microsoft (MSFT) and Intel (INTC) look attractive to me as a long-term investor, although right now only have Zacks #3 Ranks (Hold).
APPLE INC (AAPL): Free Stock Analysis Report
BANK OF AMER CP (BAC): Free Stock Analysis Report
DU PONT (EI) DE (DD): Free Stock Analysis Report
GENUINE PARTS (GPC): Free Stock Analysis Report
INTEL CORP (INTC): Free Stock Analysis Report
MICROSOFT CORP (MSFT): Free Stock Analysis Report
NORFOLK SOUTHRN (NSC): Free Stock Analysis Report
RESEARCH IN MOT (RIMM): Free Stock Analysis Report
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