5 REASONS THE STOCK MARKET IS VULNERABLE

By Comstock Partners

In our view the market, at current levels, is highly vulnerable to a major downturn as a result of negative fundamentals and high valuations.? Following is a summary of important factors likely to impact stocks in the period ahead.

ECONOMY—The economic fundamentals remain weak. ??Following the deepest recession since the 1930s the recovery has been extremely slow and too heavily dependent on an inventory turnaround and government transfer payments.? The usual catalysts for self-sustaining growth have largely been absent, including consumer spending, employment, housing and credit availability.? As we would expect after a major credit crisis, debt deleveraging has offset most of the massive fiscal and monetary stimulus undertaken by the Administration, Congress and the Fed. Growth has been slogging along at an annual rate of 2 percent or under and threatens to go even lower as stimulus efforts wind down.? In addition the dire financial condition of numerous state and local governments is already leading to sharply reduced spending (see Cisco for example) and the possibility of state defaults.? The economy is between a rock and a hard place as further stimulus would threaten to send the budget deficit out of control while austerity would send the economy careening lower.

QE2—-This is a desperate effort with little potential gain and a lot of risk.? The bet is that QE2 can reduce interest rates in the 2-to-10 year range, boosting the economy and jump-starting asset values.? But mid-range interest rates are already historically low while asset values are unlikely to respond much more than they already have on the anticipation of the move.? At the same time expectations have resulted in a weakening dollar and soaring commodity prices that could help ignite a global trade war and squeeze the profits of companies that will have problems passing through price increases to deleveraging consumers.

SOVEREIGN DEBT—-We’ve stated in previous comments that the Greek debt problem in the spring was merely papered over and was still simmering beneath he radar.? Now it’s Ireland’s turn in the spotlight.? This will probably be papered over as well, but the problem is that a number of the weaker EU members are essentially insolvent and will eventually have to be restructured with severe damage to European banks that hold the debts, particularly in Germany, France and England. ??This will continue to be a drag on economic growth in the EU.

CHINA—–With inflation threatening to get out of control, the Chinese authorities are trying to tighten monetary policy gradually to engender a soft landing together with lower inflation.? A few weeks ago we described how home building had gotten so out of control that there were at least a dozen huge ghost towns with empty houses and unused roads.? Now food prices are soaring leading to popular discontent to the chagrin of the Chinese leaders who fear the possibility of widespread rioting that imperils the regime.? With the leading economies of the U.S., the Eurozone and Japan in such weak condition, China has been the major catalyst for global growth.? Any slowdown in China would therefore put the entire global economy at risk, and we all know from experience that once a nation starts tightening, recessions are the outcome much more often than the occasional soft landings.

VALUATION—-In addition, don’t believe the story that stocks are cheap.? This misconception is based on the year-ahead forecasts of S&P 500 operating earnings.? The use of operating earnings is a contrivance that began in the mid to late 1980s to make earnings look better than the reported earnings according to generally accepted accounting policy (GAAP).? Prior to the bubble period that began in the late 1990s the S&P 500 sold at an average P/E of about 15 with a range of 22 to 7 going back 1926.? Based on our 2010 trendline GAAP earnings of about $65 the S&P 500 is now at 18.2 times the average and far closer to the top of the range than the bottom.? Secular bear markets have typically bottomed at 7 to 10 times earnings.? Similar calculations by Robert Shiller?and John?Hussman indicate even higher valuations.

All in all we think that the stock market is discounting far better results than the economy can produce in the period ahead.? As was true at the market tops in early 2000 and late 2007 the market is once again misreading the negative signals that are evident all around us.

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The content on this site is provided as general information only and should not be taken as investment advice. All site content shall not be construed as a recommendation to buy or sell any security or financial product, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of firms affiliated with the author(s). The opinions of all guest authors or contributors can and will differ from those of Mr. Roche. These opinions do not necessarily represent the opinions or investment decisions of Mr. Roche. The author(s) may or may not have a position in any security referenced herein and may or may not seek to do business with one another or companies mentioned via this website. Any action that you take as a result of information or analysis on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

A brief note on comments – The increase in users in recent months has resulted in an increase in unproductive comments. Any user who engages in the use of racial epithets or uses the comment section as a place to insult other users will be banned from the site. The comment section is welcome to all readers who are interested in asking pertinent questions and/or engaging in thoughtful, intelligent, and productive debate. In short, just be nice. Thanks.

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Time To Party In Tupperware With The Stock Pulling Back

Seal in a low basis in TUP

In case you missed the Tupperware party during the fall season, consider this week’s 2% correction an invitation to arrive fashionably late.

The “Tupperware space” was a big winner over the past two-plus months. Since September 2, Jarden Corporation, Newell Rubbermaid, and of course Tupperware Brands have rallied 12.9 percent, 10.7 percent, and 14.2 percent, respectively. This past week, Newell and Jarden bent to the market’s force, providing opportunities for those who didn’t join the party.

Since hitting a 6-month high in October, tupperware and diversified consumer products producer Jarden Corporation are down a little over 4 percent, serving to drastically repair Jarden’s technical picture. Over that time, Jarden’s relative strength index (RSI) has improved from an overbought position above 75 to a reading near 47, and the stock’s slow stochastics have fallen from an overbought reading above 80 to below 40.

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Jarden stock has been consolidating and building support following profit taking in the wake of Jarden’s third-quarter earnings report last month, potentially preparing for a new rally.

The charts for Georgia-based Newell Rubbermaid?appear even more favorable. The stock formed a rounding top pattern, but volume has been steadily declining on the downturn. Newell, who also produces writing instrument brands like Sharpie and Papermate, in addition to other products, features an RSI near 37 and slow stochastics below 12, both being indicative of an oversold position. Currently priced near $17.14, look for Newell’s technicals to form a bottom before a potential retracement to the 10-day exponential moving average and to the last strong-volume open price near $17.93 which occurred on November 5.

Newell?also has?the advantage being?priced at 19-times earnings, versus Jarden which trades at a rich price-to-earnings multiple of 47. Yet both stocks?have strong short-term potental based on the charts. Although Newell and Jarden offer extremely modest annual dividend yields of about one percent, compared with Tupperware Brands’ two percent, both stocks may be sending out?invitations to buy the dips.

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Time To Party In Tupperware With The Stock Pulling Back

Seal in a low basis in TUP

In case you missed the Tupperware party during the fall season, consider this week’s 2% correction an invitation to arrive fashionably late.

The “Tupperware space” was a big winner over the past two-plus months. Since September 2, Jarden Corporation, Newell Rubbermaid, and of course Tupperware Brands have rallied 12.9 percent, 10.7 percent, and 14.2 percent, respectively. This past week, Newell and Jarden bent to the market’s force, providing opportunities for those who didn’t join the party.

Since hitting a 6-month high in October, tupperware and diversified consumer products producer Jarden Corporation are down a little over 4 percent, serving to drastically repair Jarden’s technical picture. Over that time, Jarden’s relative strength index (RSI) has improved from an overbought position above 75 to a reading near 47, and the stock’s slow stochastics have fallen from an overbought reading above 80 to below 40.

Special Offer: Make the most out of gold’s phenomenal move higher but don’t get left holding the bag when it’s time to run. Click here for instant access to market timing analysis and specific gold, silver and hard asset model portfolios in Curtis Hesler’s?Professional Timing Service.

Jarden stock has been consolidating and building support following profit taking in the wake of Jarden’s third-quarter earnings report last month, potentially preparing for a new rally.

The charts for Georgia-based Newell Rubbermaid?appear even more favorable. The stock formed a rounding top pattern, but volume has been steadily declining on the downturn. Newell, who also produces writing instrument brands like Sharpie and Papermate, in addition to other products, features an RSI near 37 and slow stochastics below 12, both being indicative of an oversold position. Currently priced near $17.14, look for Newell’s technicals to form a bottom before a potential retracement to the 10-day exponential moving average and to the last strong-volume open price near $17.93 which occurred on November 5.

Newell?also has?the advantage being?priced at 19-times earnings, versus Jarden which trades at a rich price-to-earnings multiple of 47. Yet both stocks?have strong short-term potental based on the charts. Although Newell and Jarden offer extremely modest annual dividend yields of about one percent, compared with Tupperware Brands’ two percent, both stocks may be sending out?invitations to buy the dips.

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GOLDMAN SACHS: QE2 WILL NOT DRIVE STOCK PRICES HIGHER

Goldman Sachs is not convinced that QE2 will have a significant impact on the equity markets from current levels.? In a recent strategy note (via Zero Hedge) they cited the primary reason why QE2 was likely already fully priced in and unlikely to impact the real economy heading into 2011:

We believe QE2 is unlikely to change our sales or margin forecasts, so return prospects become a valuation debate. Our targets imply less upside, given 13.5x P/E is consistent with prior 1-2% real rate regimes.

The bullish argument for equities goes as follows: (1) The Fed buys longdated Treasuries to reduce term premium and lower interest rates across the maturity spectrum; (2) The low yields penalize individuals and corporations who hold cash; (3) individuals and institutional investors re-allocate their savings into higher risk instruments such as equities, high yield bonds, emerging market debt and equity, and commodities; (4) firms pursue new capital spending initiatives and boost employment; (5) asset price inflation has a wealth effect and spurs retail spending; (6) a consequence of lower US interest rates is a weaker US Dollar which benefits US exporters and also stimulates some incremental domestic job growth.

Our year-end 2010 price target for the S&P 500 remains 1200 or 1% above the current level of 1183. We expect the S&P 500 will trade sideways during 1Q before rising during the subsequent six months. Our 12-month forecast of 1275 reflects a price return of 8% and a total return including dividends of 10%. For details, see our report US Equity Views: Updating our price targets as investors focus on 2011 (October 15, 2010).

Three topics drive our view of the trajectory of the US equity market. (1) Sales; (2) profit margins; and (3) money flow. Below we briefly outline how each of these items will be affected by the pending QE2.

1. QE2 is unlikely to change our sales forecasts. Goldman Sachs Economics 2011 US GDP growth forecast already incorporates at least $1 trillion of Treasury purchases by the Fed. Despite the hefty forecast of Fed purchases, our 1.8% GDP growth forecast remains below the consensus expectation of 2.5%. The buy-side seems to be in the 2.0%-2 ?% range. Our current index and sector-level sales forecasts incorporate our GDP growth assumptions and therefore already capture QE2. Capacity utilization hovers at 74%, up from the March 2009 low of 68% but below the 81% long-term average, so firms are not compelled to fast-track new projects despite the availability of cheap financing. The US has a demand, not a supply, problem. The US Dollar has weakened in the 12 weeks since QE2 entered public debate and it will benefit revenues of US companies, although by less than many investors believe. S&P 500 generates just 30% of sales outside the US.

2. QE2 is unlikely to change our margin forecasts. Our index and sector level net margin estimates incorporate our US and world GDP, interest rate, inflation, oil and US Dollar forecasts and the firm’s macroeconomic view assumes $1 trillion of QE2. If the Fed successfully spurs higher inflation than we currently assume (1.1% in 2011), it will have a negative impact on profit margins because rising input costs will not be fully-passed through to the? consumer. Passing inflation along to the end customer will be particularly difficult in an environment with nearly 10% unemployment. Our 8.4% net margin forecast stands below bottom-up consensus of 9.0%. The Fed’s desire to re-inflate the economy tilts margin risk lower rather than higher. Firms reporting negative margin surprises in 3Q span the value chain from raw (X, AKS, NUE, MEE) to intermediate (GENZ, LLTC, BMS) to end-demand (AN, AVP, KMB, SLB, EFX, AVY, T) to cite just a few examples.

3. Therefore, QE2’s potential impact on the US equity market reduces to a debate over valuation. Bulls argue stocks are dramatically undervalued relative to bonds. It is true that using Treasuries, BBB corporate bonds, or TIPs in the Fed model leads to a conclusion the S&P 500 is 20% undervalued. Bulls similarly argue that QE2 will drive both yields and risk lower,? reduce the cost of equity, and support a DDM valuation above our 12-month target. Bulls implicitly argue stocks should trade at a higher P/E multiple. Our more modest return projection incorporates a current starting point valuation that shows stocks trade at a 13.5x NTM P/E multiple consistent with past real interest rate regimes of 1-2%. However, the current P/E multiple is calculated when margins stand at all-time highs. A P/E assuming normalized margins would be 14.6x closer to the long-term average. We believe the forward path of stocks will be determined by potential asset allocation shifts by owners of 70% of the US equity market. Individuals own in aggregate 53% and pension funds own 17%. Shares will trade sustainably higher if these investor groups decide to re-risk from bonds to stocks. Any shifts most likely will be gradual.

A lot of that probably sounds familiar to regular readers.

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The content on this site is provided as general information only and should not be taken as investment advice. All site content shall not be construed as a recommendation to buy or sell any security or financial product, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of firms affiliated with the author(s). The opinions of all guest authors or contributors can and will differ from those of Mr. Roche. These opinions do not necessarily represent the opinions or investment decisions of Mr. Roche. The author(s) may or may not have a position in any security referenced herein and may or may not seek to do business with one another or companies mentioned via this website. Any action that you take as a result of information or analysis on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

A brief note on comments – The increase in users in recent months has resulted in an increase in unproductive comments. Any user who engages in the use of racial epithets or uses the comment section as a place to insult other users will be banned from the site. The comment section is welcome to all readers who are interested in asking pertinent questions and/or engaging in thoughtful, intelligent, and productive debate. In short, just be nice. Thanks.

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