Monday, June 20, 2011

Laszlo Birinyi and "The Cyrano Principle"


There was a good column by Jeff Sommer in yesterday's New York Times about the current market environment.

The mood of investors has changed dramatically in the last couple of months, and no wonder. The fiscal crisis in Greece is threatening the euro zone. Unemployment remains stubbornly high. Recent US economic data has shown an economy that is slowing, and there are more worries that the collapse in housing is going to lead to a second recession.

With the federal government worried about a $14 trillion cumulative budget shortfall, it seems very unlikely that we will see any fiscal stimulative package any time soon.

Oh, and it is also unlikely that the Fed will be doing another round of quantitative easing, given the prevailing political mood in Washington.

But, as the article notes, maybe all of this already in the current stock market prices.

The piece quotes veteran market strategist Laszlo Birinyi about the market. Mr. Birinyi views the recent market pullback as simply a correction in a secular bull market, and believes that investors should be adding to stocks, not reducing.

Here's Mr. Birinyi on something he calls "The Cyrano Principle":

As for Mr. Birinyi, he cites what he calls “the Cyrano Principle”: “If the problem is as obvious as the nose on your face, the chances are that everyone else knows it, too.” The markets, he said, are very good at digesting this news and adapting to it. Sooner or later, he says, “unless there is some truly dramatic surprise — and not just something the market is well aware of” — stocks will resume what he expects to be a long run higher.

Stocks Haven’t Fallen That Much, Despite Recurring Worries - NYTimes.com

I agree with his view. Yes, I know the data is soft, but markets typically get walloped by unforeseen events, not those that are so widely broadcast as today's financial woes.

And then there's this: At a time when investors are still piling into Treasurys yielding well below 1% (on shorter maturities), stocks on many measures are very cheap. Here's a piece from this morning's Bloomberg:

Analysts are boosting profit forecasts even with the global economy showing signs of weakness. S&P 500 earnings may rise to $99.61 a share in 2011 from $84.58 last year and $61.52 in 2009, according to data compiled by Bloomberg. That’s an increase from the forecast of $95.37 on Jan. 3 and $98.70 on April 29, the data show.

Should stocks stay at current prices and the analyst prediction come true, the S&P 500 would trade at 12.8 times income on Dec. 31, the lowest level since 1985 except for the six months after Lehman Brothers Holdings Inc.’s bankruptcy in September 2008 and nine months in the late 1980s, according to Bloomberg data. Companies in the S&P 500 are forecast to earn $24.31 this quarter, up from $24.16 at the start of April.

http://www.bloomberg.com/news/2011-06-19/stocks-cheapest-in-two-decades-as-s-p-500-falls-with-earnings-climbing-18-.html

Now, to be sure, Wall Street might be too optimistic. Merrill's US quantitative strategist Savita Subramanian has noted a worrisome divergence between rising analysts' forecast and a more cautious corporate management tone. For this reason Ms. Subramanian is less optimistic on stocks than, say, Mr. Birinyi.

But still: How much "bad news" is already in stock prices?