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The Masked Tulip

This Rally May Need A New Source Of Fuel

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Liz Ann Sonders, chief investment strategist for the Charles Schwab brokerage firm, said that after seeing the Standard & Poor’s 500-stock index jump to above 940 from around 675 in just 14 weeks, a market that had been undervalued is now “fairly valued.†So a major tailwind that propelled stocks since March has disappeared.

“The initial move of investors back into the market was based on a value call,†she said. “You don’t have that value call anymore.â€

Based on historical standards, domestic stocks are certainly no longer a bargain, according to Ben Inker, director of asset allocation at GMO, the asset manager based in Boston.

“From a pure valuation perspective, we’re in a bit of a gray zone now,†Mr. Inker said. “Stocks aren’t obviously overvalued, but we can’t say they’re cheap, either.â€

So, even after this rally stocks are not cheap? Hmm, what does that say about the rally?

Because profit growth can be so unreliable in a severe recession, some strategists prefer to gauge stock prices by using so-called operating earnings, which exclude one-time write-offs like the expenses associated with closing down a factory or a company division.

Based on operating earnings, the P/E of the S.& P. 500 is a much more palatable 22 today. But that’s still considerably higher than the average of 19 for the past two decades.

What’s more, there are concerns about how quickly the market’s P/E has grown.

It’s not uncommon for market valuations to rise in the latter stages of a recession, because stock prices tend to move in anticipation of a recovery. That means prices — or the “P†in the P/E ratio — often recover before earnings do. But they don’t usually expand this fast.

Ned Davis Research, an investment consulting firm in Venice, Fla., looked at market valuations after bear markets since 1929. The firm found that in the first three months after bear markets, the market’s P/E tends to climb by about 10 percent. And the multiple has traditionally expanded 22 percent in the first six months after a major market downturn.

But since March 9, when the recent rally began, the P/E of the S.& P. 500 has jumped nearly 40 percent.

SUCH a surge in P/E ratios may be warranted if the recession ends soon and profits recover quickly.. While there are some signs that the worst of the recession may be behind us, few analysts expect profits to stage a major rebound.

And, of course, it’s still unclear whether the recession and the bear market have ended.

Still, the stock market looks much less expensive by using other valuation methods.

For example, instead of adding up all the earnings for S.& P. 500 companies to arrive at a single P/E ratio for the broad market, Ned Davis Research assesses the individual P/E ratios for every stock in the index. Then it determines the median P/E for the whole group — in other words, it finds the midpoint, such that half of the stocks in the index have a higher P/E and half have a lower one.

Based on this technique, the P/E of the S.& P. 500 is now at 15.6. That’s well above the reading of 12 in March, but still slightly below the market’s historical median of 16.5. “We’re not as cheap as we once were, but we’re not yet back to normal,†said Tim Hayes, chief investment strategist at Ned Davis.

But even if that technique is the best to use, it still means that the mind-set on Wall Street has shifted. Instead of betting on stocks because of unbelievably cheap prices, many investors are counting on the economy to rebound strongly.

In other words, instead of betting on the “P†in the P/E ratio, stock investors are banking on the “E.†But at today’s prices, says Mr. Inker at GMO, “You’re not getting paid a ton for taking on risk.â€

Sounds as if the price has got way ahead of even potential earnings in 2010!

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All those earnings are lies too. They were lies when we wer in the bubble so fook knows how many order of magnitude they are out now.

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Some think the US Fed is supporting the market. When it can no longer do this - POP!

Will the Fed help support the earnings or companies? Fed to give big business free cash to meet profit targets?

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