With markets moving 100’s of points in either direction based on what Federal Reserve members say on any given day, it is important to have a disciplined approach to investing that focuses on the facts.  So the question we ask ourselves today is:  With the equity markets at all-time highs, does the price of the market reflect its true fundamental value or is it just getting more expensive due to the Federal Reserve money supply manipulations.  We contend that it is more of the latter rather than the former and believe the “risk” in the equity market continues to be elevated, as illustrated using the facts shown below. 

Market Valuations:

• The current P/E (price to earnings ratio) is at 19.36.  P/E is a good valuation measure for how underpriced (low P/E) or overpriced (high P/E) an individual stock or market is.  The graph below shows that our market is overpriced historically.  (It is important to note that the spike in the P/E beginning in 2009 is overstated because of bank write-offs, bringing the earnings -the E of P/E- temporarily to an artificially low level – see right hand chart at bottom of the page).

Earnings Expectations:

Profit Margins at All-Time Highs with Flat Revenue

• There are only two ways of increasing earnings; cutting costs and/or increasing revenues.  Profit margins are at 9.7%, which is 36% higher than their 50 yr. average of 6.2% (graph on the left).  Corporations have been cutting costs and are as lean as they have ever been.  However, earnings have been flat since 2011, which is shown in the chart to the right.  Since there is little to no room for corporations to cut costs, they need an increase in top line revenues to grow earnings.  Revenue per share for the S&P 500 at the end of 2012 was $288.03 a share.  In the first quarter, sales were $270.77 per share and are expected to be $276.43 per share for the second quarter.   In other words, revenue as a growth driver is non-existent.  Note:  THOR was correct in our analysis that earnings would not rise.  The market is up just because it has been bid up and hence is more expensive, not because the fundamentals are better.

Household Income & Stagnant Growth:

• So we must ask ourselves, if we are going to get this top line (sales) growth where is it going to come from?  Internationally, China is slowing, Europe is in a deepening recession, and emerging markets are struggling so we don’t see much growth in overseas markets.  We also don’t see the U.S. being a major driver of this growth either and here is why:  consumers make up 70% of the U.S. GDP and household income has actually fallen since 2008.  Without growing wages and increased consumer spending, company revenues will continue to fall short of expectations (analysts project 18% growth in earnings for 2013!).

Technically Speaking:

• In the last 15 years, the Monthly RSI has only been overbought (reading above 70) 3 times, one of which is where we are today.  The previous two times the market was in this territory there were major corrections.   This does not mean the market will correct right away (last time it was overbought, the market continued to rise another 20+% before correcting).  However, it is a cautionary sign that the risk in the market is high.

Source: Stockcharts.com

Summary:

As we have stated in the cover letter, we believe the market to be priced for perfection right now.  Yes, the market has gone up but, as evidenced above, the fundamentals of the market are not the reason for the positive move.  The market has only gotten more expensive and hence, more risky.  With the market continuing to make advances, it is compelling to “throw in the towel “ when it comes to trying to make sense out of this market and join the party.  But now is not the time, in our opinion, to ignore the warning signals the market is so clearly flashing.

Past performance is not indicative of future results. Opinions expressed are those of THOR Investment Management, Inc. and are subject to change, not guaranteed, and should not be considered recommendations to buy or sell any security. This presentation is limited to the dissemination of general information pertaining to THOR’s investment advisory/management services.