The Enterprising Investor’s Guide for 7-19-2010

The price-to-peak earnings multiple has fallen to 11.9x as of the close of trading on Friday.  The stock market has swung wildly over the past two months, but the net result has been essentially just a move sideways for the last 9 weeks of trading.  With the US stock market now having fallen 3 out of the last 4 weeks, the bears have begun to make more noise as the case for the double-dip still exists.  Macroeconomic data has been worse than most expected of late (The Fed warns of slower growth, retail sales, employment, consumer credit, etc), which does make us apprehensive.

The beginning of earnings season has yielded mixed results with some of the most economically sensitive stocks such as Alcoa (AA) and CSX (CSX) doing surprisingly well.  However, thus far financials and growth stocks like Google have underwhelmed investors and may cause some analysts to reevaluate their growth projections.  Just one week into second quarter earnings season is clearly too small a sampling to determine an overarching trend, and thus far we have yet to see one emerge.  We continue to believe the market appears priced attractively based on still improving fundamentals.  Of course, there are a number of potential pitfalls in the months ahead, but we think that investors should be cautiously optimistic towards the stock market’s current valuation.  Undoubtedly, many investors are caught up in the day to day gyrations of the market, but we think investors should remain focused on the long term.  Historically speaking a price-to-peak earnings multiple of around 12x has been a very justified time to deploy resources into the market.

The percentage of NYSE stocks selling above their 30-week moving average was 36% after last week’s market action.  Overall market sentiment recovered somewhat in the last week, but it is not showing an overly bullish or bearish posture in our estimation.

Perhaps most frustrating to us in this market environment is the fact that the market appears to be driven more by technical analysts and traders rather than fundamentals.  There is always a tug of war between these two competing schools of market analysis, and while we see some value in each school, we fall in the camp of the fundamental analysts.  In our experience, long term stock returns

are determined by a company’s ability to generate earnings and grow sales.  Lately, the markets have taken a breather with the recent correction, as we hoped that it would after more than a year of rallying without so much as a 10% pull-back.  Now with the price-level lower and reported earnings continuing to grow, we think this disconnect could work to the benefit of long term value investors.

At this time, we think value investors should begin to begin to slowly build positions in high-quality stocks that have fallen out of favor with the market.  By no means do we think that the volatility will subside anytime soon; rather, we think that wild swings may be the norm for the rest of the year.  With that said, by starting with defensive, dividend-paying stocks an investor can limit the risk in their portfolio and buy solid stocks at attractive value.  A few examples of these sort of stocks include; Chevron (CVX), Eli Lilly (LLY), Microsoft (MSFT), Northrop Grumman (NOC), Verizon (VZ) and Walmart (WMT).  All of these companies are among the best in their respective industry and will weather any upcoming volatility better than the rest of the market.

Read the original story at Ockham Research