Can Valuations Support The Market Move Higher?

Can stock valuations support the current move higher in the broad market? That has to be the single biggest question relative to the markets today. Are stocks too expensive relative to valuations looking forward relative to growth? That debate could go on forever without a clear decision. Mr. Buffett says, “Price is what you pay, value is what you get.” Thus, is the value too high for the broad markets? On a relative basis the answer is no factoring in normal economic growth of 2-4%, but when you look at all the opinions, many believe, yes. The reality is more in-between the two opinions that dominate the headlines. Sentiment is what will ultimately drive the markets up or down short term. And sentiment is on the side of the buyers currently. The current mentality isn’t on the fundamental valuations, they are on the Fed stimulus plans and second quarter earnings with a twist of forward guidance. Thus, even if we could substantiate an argument that stocks are too expensive fundamentally the driver of prices (buyers) aren’t looking at the fundamental data, they are driven by a positive sentiment towards stocks based on outside events… the Fed. I know that is a wordy answer to a simple question, but knowing what is driving the thinking of investors versus the data, puts the trend in perspective. I wrote a note on Monday about the fundamental data being ignored and the data doesn’t matter until it matters. The bottom line for stocks is the Fed mentality is still in play. Until the fundamental valuations matter… they don’t matter.

Earnings are still a mixed bag for investors as Microsoft, Intel, IBM, Ebay, Google and Detroit all missed earnings and fell short on revenue. That has put the NASDAQ 100 index is a vicarious position heading into the final day of trading on the week. If the after-hours prices remain at lower levels we may see a drop of 0.7% at the open of trading for the large cap index. Thus, the question asked above may get or produce a different answer short term… fundamentals do matter. In fact, this will be a good test to see where the sentiment of the investor lies currently relative to earnings. If they ignore or shake off the data without much selling the focus is still on the Federal Reserve and the handling of quantitative easing or $85 billion in bond purchases per month, not the fundamental valuation of companies. Time to see if fundamentals do matter!

Yahoo reported disappointing numbers, but climbed 10% on Wednesday, because of the rosy picture painted by the company relative to future growth and the changes being made that will push earnings higher longer term. Investors want to believe things are going to better in the second half, as many analyst predict, and the report from Yahoo played right into the path of hope/sentiment from investors and pushing the stock up more than 10%. Again this shows the willingness to believe the valuation are cheap or worthy of investing in light of the future expectations. Sentiment validated again it is on the upside and not worried about the fundamental data today.

There are plenty of reasons to be worried about the current market conditions and disregard current valuations, but the trend for stocks remains on the upside and we all know the trend is your friend… and equally important, don’t fight the Fed. Until the sentiment shifts and reality of the current valuations versus future growth projections sinks in, ride the uptrend and trail your stops to exit if the trend reverses. Then you will know that fundamentals matter, but not until.