Are Stocks Undervalued Right Now?
It’s a scary time to be in the stock market. Analysts are expecting a drop in earnings this quarter. Ben Bernanke is hand wringing about how slowly the economy is recovering. And, of course, Europe’s got its own set of world-shaking problems.
But so what?
Right now, I’m reminded of a quote from hedge fund manager John Griffin: “The future is uncertain; it is always a difficult time to invest.”
To make investing less difficult, it’s crucial to look objectively at the evidence and make an unemotional decision. Today, I want to delve into some fundamental/technical research to show you why the market is woefully mispriced right now.
Just because the type of trading I focus on is technical analysis-driven doesn’t mean that fundamentals (like earnings and balance sheet numbers) aren’t part of my thought process. They are.
In the real world, fundamental and technical factors work together to impact stock prices. And more often than not, they can provide some important evidence to support our technical view of the broad market.
In the last few weeks here in the Sleuth, I’ve focused on technical factors — like price action and sentiment — to argue that the drop that started in April was just a correction, not the start of a bear market. Now, have a look at some fundamental data:
The chart above comes from James Paulsen at Wells Research. It shows the price of the S&P 500 (top) versus U.S. corporate profits since 1947. Unfortunately, the scale is a bit hard to read, but you can access a high-resolution version here. You can see that both prices and profits have been in sustained uptrends for the last six-and-a-half decades — in other words, the climbing price of the S&P has been justified by the bigger profits that companies have been bringing home.
You can also see that sometimes these two measures can come out of synch with each other: in the late 1990s and early 2000s, stock prices ballooned while profits slid lower, a sign that the market was overpriced (incidentally, that’s good evidence of why technical analysis is so important — fundamentals clearly can’t tell the whole story). And now, the opposite is happening.
Since the 2008 market crash, corporate profits have pushed above their historical trend line to new all-time highs (the period is circled in the chart). At the same time, stock prices are still well below their own trend line. That suggests that stocks are fundamentally cheap right now.
And it means that the technical rally I told you about yesterday has some serious fundamental backing behind it. Of course, that doesn’t tell us that the market will go straight up from here — investors should still expect the unexpected, after all.
But it definitely adds to the picture that now’s a good time to be a buyer. I’d recommend turning back to the technicals to help figure out what you should be buying right now. Now, you may be wondering how…
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