Today's Comments (Short Term Outlook)

P/E Ratios Another big day for stocks yesterday as the major indices all picked up over 1% on the day.  The I-fund jumped 2.3% after the dollar dropped nearly 1% to a six-week low.  Bonds also rallied as the F-fund picked up 0.34%. The S&P 500 did not quite reach the highs made in mid-June, but at 951 it did make a new closing high for 2009.  Volume has not been very heavy, something you'd like to see at breakouts, but we're in the middle of the summer and light volume can be expected.                   Chart provided courtesy of www.decisionpoint.com, analysis by TSP Talk The PMO is making another buy signal as it crosses over the 10-day moving average. Let's take a look at the recent S&P 500 earnings and price to earnings ratios.  The price earnings ratio, or P/E, is the ratio of the S&P 500 price in this case, and the earnings for the companies within the S&P 500. As price moves higher (assuming no change to earnings), the P/E ratios get larger.  As earnings move higher (assuming no change in price), P/E ratios get smaller. The lower the ratio, the better the value of S&P 500.  A high ratio usually means the S&P 500 is more overpriced.  I consider myself more of a technical analyst because values can fluctuate dramatically, and overpriced stocks don't always mean they will go down, just as undervalued stocks don't always go up.  It's easier to just follow the charts, in my opinion.  The data in the chart and commentary below is based on "As Reported Earnings Per Share" as opposed to "Operating Earnings Per Share".  So, your numbers may be different but the ratios, for comparison purposes, should be the same.  Here's some data: Since 1988, P/E ratios on the S&P have varied between 11.7 all the way up to 60.7.  The 60.7 jump came in 2008 when earnings dropped all the way down from $66.18 in 2007 to $14.88.  The 22-year average is about 25.0.  The 2009 P/E ratio, is 31.73.  That is based on 2009 earnings estimates of $29.97 and the S&P closing price of 951.  951 / 29.97 = 31.73 31.73 is  heck of a lot better than the 2008 ratio of 60.70, but it is still slightly higher than the 25.0 average.  But, based on 2010 estimates, the 2010 P/E ratio is 25.5, which is more in line with that average P/E.  That of course assumes the S&P 500 does not move higher in price.  As the S&P 500 rises, the P/E ratio will also rise - assuming earnings estimates do not also rise.                          The problem with this is that earnings estimates, as well as prices, are constantly changing so it is a moving target.  If the P/E was always 25.0, it would be easier to put a price target on the S&P 500.  You'd just need to know the earnings estimates. A few things to notice in the above chart, in no particular order: - Earnings were 81.51 in 2006, and dropped to $14.88 in 2008.  Along with that drop, the P/E rose from 17.4 to 60.7.  - This year's earnings estimates are $29.97, more than 100% higher than the 2008 earnings. - Next year's earnings estimates jump to $37.26, or plus 24%.  If this is accurate and the P/E ratio stays near 31.73, that would mean a move in the S&P 500 from 951 to about 1180. - If the P/E of the S&P 500 ends 2010 at the average P/E of 25.0, the S&P would close 2010 at 932 based on the $37.26 earnings estimates.  - If the P/E happens to jump up to 60.7 as it did in 2008, the S&P would close 2010 at 2236. - If the P/E happens to fall to the low of 11.7 as it did in 1988, the S&P would close 2010 at 436. You can see why earnings reports and future guidance by companies are so important to investors.  Although, since price, the earnings, and P/E ratios fluctuate so much, it is difficult to base your short term position on these fundamentals.  It is more for a longer term picture when there is stability in markets. After moving basically sideways for about a month and a half, the dollar is not look very good with the recent move lower.  It looks as if it will be testing the lows made in early June quite soon, and with the trend moving decisively lower, it will likely make a new low.                   Chart provided courtesy of www.decisionpoint.com, analysis by TSP Talk As we've said before, a falling dollar is not necessarily a bad thing for stocks.  Commodity driven companies, companies that do a lot of business overseas, and as we've mentioned many times, stocks in the International Fund (I-fund) also benefit.  I'll leave you with a CNBC video interview with economist Nouriel Roubini, who said his comments regarding the economy last week, which triggered a big rally on Wall Street, may have been taken out of context.  I apologize to those of you who can not view videos from your workplace. This is not to promote doom and gloom, but rather it basically ties in with the P/E commentary above.  While the worst may indeed be behind us, don't expect earnings estimates to be raised too much over the next 12-18 months, during a recovery period of 1% to 3% growth at best. That's all for today.  Thanks for reading!  See you tomorrow!