Has the Market Topped?

The second quarter earnings season is almost over, and what a season it has been!  About three quarters of companies soundly beat earnings estimates, and many firms raised their guidance for the rest of the year.  That, together with a number of rather benign economic news, propelled the markets to their yearly highs, and to nearly 50% gain from the March lows.  Did this 5-month run happen too fast and is it too much?

While the rise has been extraordinarily swift and sharp by any standards, one needs to put it into perspective.  Year to date, S&P 500 is up solid, but unremarkable 10%.  It is still down nearly 20% compared to one year ago.  And it is still more than a third off its top reached in the fall of 2007.  There is a similar, and often even more exaggerated, situation with individual stocks.  A number of them tripled since March, but they are still down 20-30% compared to one year ago.  In fact, if we could erase tremendous volatility of the year past, we would be in the run-of-the-mill, ordinary bear market.

So where do we go from here?  Will the rise continue or is the bear still in charge?  No one is qualified to make a short-term prediction.  However, it does appear probable and even likely to see some consolidation in the market during the next two months, especially since little new earnings reports will be coming out until Q3 results start rolling in mid-October.  First and second quarter results were better than expected, and according to cockroach theory, this is likely to continue.  In fact, analysts are already increasing their Q3 projections from a loss of 8.5% to a loss of 2%.  I wouldn’t be surprised to see a gain.  And in Q4, earnings are expected to rise by massive 270%.  Year 2010 will also see easy earnings comparisons, which bodes well for stocks.  This should also put a lid on P/E ratios — currently they are elevated for many companies as is always the case during difficult times.

As I mentioned, the economic news have been rather positive lately.  We have seen improvements in housing market; manufacturing activity and industrial production are increasing.  The Fed finally stopped calling the economy contracting or slowing.  Most likely, the recession is already over, and we will see slight GDP growth in Q3.  Not just the US is improving: the recession is now officially over in France and Germany, and emerging markets continue their growth.  On the negative side, consumer sentiment is still rather grim and unemployment is high.  Until it improves, the growth is likely to be rather muted.

The huge market move in late 2008 – early 2009 took practically everything down, and the recent move took practically everything up.  Now, however, I think that we are returning to more or less normal market conditions, where the skill of stock picking will make a difference again.  Some stocks are fully valued, but there are still plenty of bargains and many opportunities for a long-term investor.