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Jelly Roll Capital Equity Research |
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Market Analysis, Education, and Wall Street-Quality Stock Reports |
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Market Directions, Corrections, and Beyond |
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This is a website for value investors. All of the information you find in our stock reports is fundamentally-orientated, and we don’t attempt to call tops or bottoms in stocks. The goal is to find stocks that are positioned so you don’t need to buy them right; but will see excellent returns whether or not you can enter right at the low. Still, our expectations for future prices is important, because if we see stocks in general being cheaper soon it could be an event worth preparing for. Combining a look at a few broad technical indicators with market valuation metrics produces an interesting picture of the market’s condition. From a technical standpoint, the market is in the process of correcting. This is apparent from the decline seen in charts of the percentage of stocks above certain moving averages, bullish sentiment indicators, and advance/decline lines. Technical analysis practitioners say the market likely has another several weeks of downward pressure before the correction is finished. Right now the markets have moved back to November 2006 levels, and my own extrapolation of the technical data suggests we need to give back at least another 50 points on the S&P 500 - that works out to about -3.5%, with a slightly greater loss for the more overvalued Nasdaq. Fundamentally speaking, the markets from about late November onward were overvalued from a cash flow perspective. While much of the rally was reasonable and driven by undervalued large-cap stocks, eventually the low-quality stocks in the market were being bid up too much as well. The free cash flow yield of the major indices was at an abysmal rate relative to bonds, as forward P/E multiples and EBITDA valuations seem to have become prominent on Wall Street. Such a phenomenon is largely seen in the speculation surrounding overpriced stocks such as Baidu.com (BIDU) and Google (GOOG), and in the cyclical stocks that rallied even more than the S&P 500 off of lows in June 2006. The disproportionate increase in the Cyclical Index compared to the rest of the market was a telling sign of over-optimism among investors, which traditionally leads to a market imbalance and correction. As I mentioned earlier, I am currently less optimistic about America’s economic outlook than most, so general strength in cyclicals was a puzzling development to me, and one that apparently set the market up for disappointment. Should my predicted weakness in the general economy materialize, profit growth will become more difficult, and correspondingly investors will likely begin to place a larger premium on companies that can consistently grow earnings. Think back to the end of 2005, and how many market pundits were calling for large-cap value stocks to shine in 2006, taking the place of small-cap stocks that had been rallying ahead of the market for the previous several years. By and large, those predictions came true - meaning we have seen a small-cap rally and a large-cap value rally in this bullish cycle. The tendency for market sectors to undergo a reversion to mean, combined with my economic outlook, make me think that growth stocks - specifically the larger companies that haven’t already seen valuations skyrocket - will likely be the next group to outperform. Large-cap growth should have the stability that investors are looking for in risky times, while still providing the bottom-line growth required for stock price appreciation. A few large-cap growth stocks I like right now include biotechnology company Amgen (AMGN - $59.30), computer maker Dell (DELL - $22.50, DELL Stock Brief), United Technologies (UTX - $64.60), and South African-based energy company Sasol (SSL - $28.76). Once I believe the market has reached a point of stabilization, I’ll be sure to note that. Until then, keep an eye on these stocks, as I believe they are compelling values in themselves and also positioned to benefit from a shift in investor sentiment and asset allocation. The following chart shows the 5 year returns of the iShares S&P 500 Value Index (IVE - Blue), the iShares S&P 500 Growth Index (IVW - Red), and the traditional S&P 500 (Green). |
