Thomas Nogales November Letter – Hussman plus S&P500
Read the Thomas Nogales November newsletter here
Tom doesn’t see fair value yet. He provides an excellent summary on TIPS
Tom is one of the people who have been accurately calling this bear market, he sees another 20% grind or drop as possible. Hussman who was also calling the bear has said he sees fair value now and Buffett is waving his all clear and providing his quotable advice. Tom concludes by saying:
“These are very difficult times and it’s going to get much worse. We may see the breakdown of the US private and public retirement systems and municipal bankruptcies. Get out of debt and live cheap. It is quite certain that we’ll see laws and actions by the government unlike anything in the past. Stay watchful.”
Is another 20% lower possible? Let’s look what could cause that.
According to Nogales:
“During severe recessions the PE ratio of the market often drops below 10. The forward PE is 19 right now based on expected reported earnings. I’m not saying it will happen but in a severe bear market the S&P500 could go far under 600. That may sound incredible but it’s certainly not impossible using history as a guide.”
The latest spreadsheet of earnings by sector for S&P500 are available here
The data from 28 October shows expectations still for Q3 2008 marking the trailing twelve month (ttm) earnings low point with S&P500 operating earnings bottoming at $66.94. I don’t have the expected reported earnings at hand, but I’m sure you realise reported earnings are lower. Unless the S&P estimates are still too high 600 looks unlikely. With the S&P at 968 a forward P/E if 19 implies forward reported earnings of $51. 20% drop from here implies a low of 774. So Nogales has created a band of almost 200 points from below 600 to almost 800. The 52 week range stands at 839 – 1,523.
The forward operating earnings low point occurred at the same as the individual quarterly low Q4 2007, forward earnings then where $66.94.
Q1 2008, the latest available, marked the low in reported ttm earnings of $60.39.
While I do believe in market timing, consistently catching the turning points is impossible. I aim for close enough being good enough and within 20% of this bottom will do nicely. A retest of the lows and a lower low are both possible and some market participants will be looking for it to happen. I recommend placing low limit orders on you favourite stocks to capture any cathartic lows, try 20-40% depending on the stock. If the S&P 500 dips under 800 I will start to employ margin. I’m close to 100% invested now and in Australia have been selling my ballast stocks like Telstra to buy more volatile shares with better reward to risk profiles.
If you’d prefer the council of Hussman here is view as of November 3.
“Presently, about 75% of the Fund’s portfolio remains hedged with out-of-the-money put options. These puts are there to hedge against any abrupt and deep continuation of recent market losses, which I don’t expect, but can’t rule out if only because of recent volatility. We are not hedged against smaller, local movements of several percent, so the Fund will tend to fluctuate both higher and lower with the market for now, though in a slightly muted way.”…
“From my perspective, the whole issue of bull market versus bear market doesn’t get investors anywhere. Asking whether stocks are in a bull market or a bear market is like asking Columbus what kind of trees are planted along the edge of the earth. The question itself makes a false assumption about how the world works. My view is that bull markets and bear markets don’t exist in observable reality – only in hindsight. What gain is there to investing based on something that’s unobservable when you can manage your investments based on directly observable evidence?
What we can observe directly is the prevailing status of valuations and the quality of market action. We can also look at more than a century of market history and get an idea of what the return/risk profile of the market has been, on average, given that prevailing evidence. As of today – not two weeks ago, not two weeks from now, but today – the prevailing status of valuations and market action is one that has historically provided a strong average return/risk profile, but with rare “outliers” that encourage us to retain a hedge several percent below the current level of the market, strictly to insure against an unlikely further breakdown. “
Associated Article
More information and links on S&P500 earnings
More on Performance once the a recession is recognised by Bill Hester.
Why Are Perma-Bears Coming Out of Hibernation and Recommending We Buy? at Seeking Alpha
Past Thomas Nogales Posts
October 2008 – TARP
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