Tuesday, January 5, 2016

Fundamentals Coming to Bear

The S&P 500 at current levels, 2010, is trading at a P/E of 17.2 on 12 month trailing earnings of $117.  It is trading at a P/E of 16.0 on forward 12 month earnings estimates of $126.  There was a 1% earnings decline over the past 12 months.  The earnings estimates are looking for 8% earnings growth this year.  Estimates look too positive to me considering oil is trading at $36, and doesn't seem to budge.  That will kill the earnings of energy names.

These earnings are coming after a huge expansion in earnings over this economic cycle, a big gain in profit margins, and with a big tailwind of falling interest rates.  Those tailwinds are going to be minimal going forward.  There is no more QE so that will kill any hopes of further drops in interest rates unless the economy weakens, which will hurt earnings.

Sometimes the crowd is right.  The market is overvalued, and we are late in the cycle, with credit problems cropping up and with growth slowing not just internationally but in the US.  If so many people weren't so bearish, it would be a slam dunk short at these levels but we're probably going to have to shake out the bears one last time before we can go down in earnest.

I could care less about China or Saudi Arabia or Iran.  Those are red herrings.  What matters is the price of oil, which determines whether you get a bunch of high yield defaults or not and affects S&P 500 earnings, and the growth in the US.  What is being missed in the focus on China is that the US economy is slowing and probably peaked out in 2014.

In any case, I think Treasuries will outperform the S&P 500 easily this year, and I would use any rallies in the S&P over the coming months to buy Treasuries for the long term.  1.60% on the 10 year is very doable this year once the investment community realizes that the Fed can't/won't raise rates anymore.

Short term, I expect a little bit more weakness but probably we don't get down to 1900 on this down move.  But I do expect us to test the 1980 area later this week.

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