TSP Talk – Stocks must be getting cheap, right?

Good morning. It’s your Monday dose of TSP Talk.

The market closed modestly higher again on Friday, as the TSP stock funds tacked on between 0.4% to 0.9% on the day. The 4-day rally took the S&P 500 up nearly 11% for the week, and after an awful start, it is now positive in the month of March.

Whether you were a bull or bear, you had to realize that sooner or later we’d see a decent rally after what happened during the first 9-weeks of the year, but it still is never easy to make the call. I thought we’d rally in late February and I got eaten up a bit and had to run back for cover. Then, out of nowhere, we got the 7% rally on Tuesday and it seemed too late to try to play any remainder of a bounce. I was still thinking about the – sell any 2 or 3 day rally in a bear market rule.

The question now of course is whether or not this rally is going to produce anything more than the prior one-week wonders we have seen in the market since this bear market started. Since September, every week that had a gain of more than 4% was met with a loss the following week, by an average of -4.4%. Being an options expiration week, it should be interesting in that there can be some manipulation with March options and futures contracts expiring on Friday.

The S&P 500 remains in a downtrend and has now rallied over 13% off of its recent low. We know that 20% rallies in a bear market are not uncommon, so we could still have some upside potential, but there is plenty of resistance overhead and I just don’t see anything that makes me believe this is anything more than a bear market rally. There is a lot of hope out there, but hope does not make a bottom.

Chart provided courtesy of www.decisionpoint.com, analysis by TSP Talk

I am much more of a technical analyst, looking at charts and indicators to help me make my decisions, but I thought I’d share a little part of the fundamentals side of the story today, with a little help from our friends at DecisionPoint.com.

The chart below shows us the earnings for the 4th quarter of 2008, as well as the earnings estimates for the following four quarters. For those who may not follow the “fundies”, the P/E, or price earnings ratio, is the ratio of the price of the S&P 500 in this case, and the one-year earnings estimates.

Based on historical data, I think Decison Point’s assumption that a P/E of 10 or less is low and would make stocks undervalued is fair, a P/E of 15 can be considered fairly valued, and a P/E of 20 or more would be overvalued.

Chart provided courtesy of www.decisionpoint.com, analysis by TSP Talk

Being that the 4th quarter of 2008’s earning were -$20.73 (that’s negative $20.73) we will throw that out of the 1 year equation and use the following 4-quarters, 2009 Q1 through Q4.

Where the S&P 500 is priced now (756), the P/E is 23.3 based on the GAAP earnings of all 4-quarters.

756 divided by Q1-Q4 earnings of 8.36+8.25+7.98+7.82, or

756 / 32.41 = a P/E of 23.3

If the S&P 500 is going to have a P/E of 20.0, which is still overvalued, the S&P 500 would have to be about 650.

If the S&P 500 is going to have a P/E of 15.0, which is fairly valued, the S&P 500 would have to be about 486.

If the S&P 500 is going to have a P/E of 10.0, which is undervalued, the S&P 500 would have to be about 324.

The one thing that could happen to make things better P/E wise, would be for earnings estimates to be moved higher. Unfortunately, I’m not sure this economic environment would be conducive to seeing higher estimates, but that is what the fundamentalist would be looking for, at least the bullish ones. If the estimates are not raised, it means this market is actually overvalued by historical standards.

The dollar has broken its recent sharp uptrend and has triggered a PMO sell signal. If a pullback is coming, this is not necessarily a bad thing for stocks, but it does suggest that the I-fund may outperform the C and S-funds over the short-term.

Chart provided courtesy of www.decisionpoint.com, analysis by TSP Talk

What a falling dollar might do, however, is create a rise in the price of commodities including oil, gold, copper, and even foods such as soybeans, wheat, etc. so we may eventually have to deal with the issue of inflation, which has not been a problem recently. That in turn would cause the Fed to raise interest rates, and while none of it is bad in and of itself, you can see where there could be potential problems if the economy does not start to show signs of improvement. But, the fact that these commodities rise can actually be a sign of economic improvement so it will be an interesting cycle to watch play out.

That’s all for today. Thanks for reading. These commentary are updated daily on www.tsptalk.com.

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