Happy Valentine's Day! and ... chills from Shiller, Murphy's and Hulbert's sober bits, and the importance of being earning-est

HAPPY VALENTINE'S DAY! Be sure to spend time with the ones you love today. Pay them good attention - it's good for you too!

Let's cover a smattering of personal comments, news, and economics, and then go out and enjoy a great Valentine's Day! At some point later this weekend, I'll do chart reviews to cover where gold may be going, as well as other markets we cover.

First, a personal note and request: This blogsite was born as a result of a terrible tragedy. My trading mentor who taught me and others a number of great things about the markets - how to size up with Elliott Wave, Fibonacci, and additional perspectives, when to TMAR, how not to worry about trade setups (identify when wrong and get out, then re-assess) - all sorts of good things to know ... died suddenly of a heart attack in October. Only in his 40's, he left behind a devoted wife and two lovely young daughters. Sadly, despite his trading success, the situation is not at all what it should be for them - he was struck down right when he'd been putting his all into building his trading analysis and education business. He had great timing instincts, except his passing was terribly ill-timed. This is why my site is dedicated to him and his family - I try to continue the tradition of helping myself and others investing and/or trading the markets, I ask nothing for myself. So please - on this Valentine's Day, please "show the love" that his family is so sorely missing now, dig deep, and make a hearty donation to his surviving family - using the "donation" button at the right side of this page.

And I will thank you deeply for it, and they will appreciate it more than you may ever know.

In other news, the U.S. markets are closed on Monday. Feels fitting somehow. As you'll find when you read more below, as well as other items on this site recently, we're feeling pessimistic about the Dow Jones Industrial Average and other major stock market indices.

Here's some news displayed today at MarketWatch.com:
• BANKING CRISIS
• FDIC seizes four banks - Florida, Illinois, Oregon and Nebraska bank closures make 13 failures so far this year.
• Weak banks may have to be nationalized
• Tax measure to help sale of toxic assets

Isn't that enough to cheer you up, this holiday weekend? But wait - there's more! In this article Feb. 12, A trip down memory lane: P/E ratio making a comeback, MarketWatch's stalwart Mark Hulbert states that, "Believe it or not, the stock market's P/E ratio has risen in recent months." Hu-uh??! Yes ... let's take a look at what he explains in this article:

Here's today's investment pop quiz: Where do price/earnings ratios stand today relative to several months ago, as well as to the beginning of this bear market in October 2007?

If you're like most investors, your answer to this pop quiz is that p/e ratios have come way down. After all, the stock market - which, needless to say, is the "p" in the p/e ratio -- has fallen by more than 40% over the last year and a half, and by more than 30% over the last four months.

Based on earnings on an "as-reported" over the trailing 12-months, the p/e ratio for the S&P 500 index (SPX:S&P 500 Index, 826.84, -8.35, -1.0%) stood at around 20 at the stock market's top in October 2007. At the beginning of 2008's fourth quarter, furthermore, the ratio stood at 25.4.

Are you sitting down?

The comparable p/e ratio as of Thursday night (Feb. 12), based on data from Standard & Poor's, is 29.1.

How can this be, you might ask?

The answer is simple: Earnings in this bear market have fallen even faster than has the market itself. And no matter how fast the "p" in the ratio is falling, the ratio has to climb if the "e" is falling even faster.

Indeed, today's p/e ratio is higher than 97.8% of the monthly readings dating back to 1871, according to data compiled by Yale University Finance Professor Robert Shiller.

A legitimate objection to this historical comparison is that p/e ratios often mushroom during economic recessions. That's when corporate earnings are particularly depressed, which in turn works to artificially inflate p/e ratios. In the latter months of the 2000-2002 bear market, for example, the S&P 500's p/e ratio ballooned to over 45, according to Shiller's data.

But this argument only partially explains why the p/e ratio is not showing stocks to be as undervalued as most investors would otherwise guess.

Consider, for example, a modified p/e ratio that Shiller calculates; one of its virtues is that it overcomes the problems associated with artificially depressed earnings at bear market lows. The denominator of this modified ratio is average inflation-adjusted earnings over the trailing 10 years. Call this modified ratio "p/e10."

Using Shiller's data, I estimate that the current "p/e10" stands at around 14, versus the long-term average over the last 130 years of 16.3 and a median of 15.7. Using this "p/e10" measure, therefore, the stock market is seen to be only moderately undervalued. That's the good news.

The bad news is that, even after an incredibly punishing bear market, we're not even close to the undervalued end of the valuation spectrum. Just consider one data point from the historical record: At the bottom of the 1973-1974 bear market, "p/e10" dropped to 8.3, only slightly more than half of today's level.

To be sure, these historical comparisons don't allow us to pinpoint how close we are to a market bottom, either in terms of price or time. But it does serve to illustrate, as Ned Davis of Ned Davis Research recently put it, "How much fluff and leverage there is in the system, killing earnings."

I've added emphasis in some places to make sure some of Mark Hulbert's and Robert Shiller's data points stand out. While we normally track technical analysis on this site, because you can find plenty of "fundamental analysis" floating around - every now and then some fundamental analysis comes forward with outstanding information that shouts for attention. This is one of those times. Pay attention, folks - the fundamentals do stink for most companies right now!

Are you a "visual investor" like me (and as suggested by the title of the book out, by Stockchart.com's chief technical analyst John Murphy)? Then just wait for a bit, I'll share a chart about earnings. Just quickly, John Murphy's interview was aired on Bloomberg tv last night. Asked about what the technicals are saying about market direction right now, he pointed out that when the put-call ratio is low, that's bearish for the market ... and stated, "the put-call ratio now is the lowest it's been in two years." Folks - I don't know just which measure he uses to see that, but it's what he said, so look out. He said the advance/decline measures aren't helpful, and he thinks we'll test the November lows, and then "we'll see" from there. The only sectors he views as positive (based on being above their 200-day moving averages) are healthcare and specifically medical and biotech (Bristol-Myers, Schering-Plough, Abbott Labs, Medco Health Solutions, Gilead, and Genzyme).

Murphy added that we'll know when the market is really ready to turn, because then those healthcare/medical sectors will top out and conversely, the following sectors will finish bottoming and turn up: consumer, financial, retail, and small caps.

Okay, now let me get to a chart I've been wanting to post for a few days now. It isn't my own chart, it's one of the free ones you can see at Chart of the Day.com. Here's their description and the chart:

It has been said that earnings drive the market. That may be the case but as of late it's been all downhill. Today's chart illustrates that S&P 500 as-reported earnings have declined over 60% over the past 17 months, making this the largest decline on record (the data goes back to 1936). In fact, earnings are currently lower than they were back in the mid-1960s.

(emphasis added)

This chart of inflation-adjusted earnings apparently was generated a week ago. I would think Da Boyz on Wall Street have been tracking such information - golly, do ya think that might have anything to do with why the markets haven't put on the rally "everyone" was expecting so far this year?!

Of course, for actually tracking where the markets are going, I'm going to stick with technical analysis - it's the most reliable way to take the pulse of the market and detect its strength or weakness. But when cross-checking against the fundamentals - well, let's just say, may as well enjoy the love of your family and friends this Valentine's Day weekend - it really is the only thing of value that's proving to have staying power!

**Updated - while we're comparing how S&P 500 companies' earnings look over the decades, let's also take a look at my weekly and monthly charts of the SPX index. Here's how my weekly SPX chart looks now. It's funny how the "C=Z" marking I placed there weeks ago, now looks "too high" on the chart - it's a function of how the chart annotations display while the chart moves through time, evidently. When I first placed it there, I intended the "C=Z" level to be approximately 600/550 to correspond with the large Elliott Wave flat on the monthly chart (although 640 now looks interesting if it could be a triangle target - IF):


For that matter, let's see my SPX monthly chart too:

And for those interested in the VIX, take a look at the VIX - as well as ISEE put/call, and other sentiment data - I've posted today, over at my UBTNB3 site (which you can find in the links within my "Welcome" paragraphs in the upper right-hand side of the page) (underneath my public-service FDA information on the peanut-related recalls and the UnbiasedTrading logo).

Here are some similar interesting analyses you might want to check out, which are based on the Commitments of Traders (COT) data we've discussed here from time to time - the COTs Timer folks have been setting up an interesting system to glean investment and trading intelligence out of those data:

New S&P 500 Setup Bearish (COTs Timer, 2/13/09)
S&P 500 Bearish, Data Mixed for Gold (COTs Timer, 2/13/09)

And, a reminder - always be careful out there, and happy trading! I say that because if you aren't trading with the trade management techniques (stop loss protection, and taking profits when you have them, etc.), and you cannot be happy with your investments or trades, then change your situation so you can be happy ... better for you and your loved ones ... which reminds me once again, do enjoy this holiday!