Listen to crowd at your own risk

12/15/2008


Opinions, it is said, are like armpits. Everybody has a couple, and a lot of them stink.

Economic prognostication is risky at the best of times, yet the airwaves and print media are crowded with bold proclamations of doom.

While pessimism is reasonable in the current climate, panic is not. As legendary investor Benjamin Graham said, “Even the intelligent investor is likely to need considerable willpower to keep from following the crowd.”

With that warning in mind, we consider opinions from the two of the most important voices in the market — and how much value to ascribe to them.

Wall Street analysts
Analysts want to believe the best. But in recent weeks, reality has set in. Considering that analysts tend to be optimistic, the fact that consensus 2008 and 2009 profit estimates for the S&P 500 Index have declined every week since mid-September makes a strong statement about the level of pessimism on Wall Street.

The 2008 consensus has declined fairly steadily since the end of June. Yet until mid-October, Wall Street still expected S&P 500 profits to grow more than 20% in 2009. As the chart below shows, estimates for both years have fallen precipitously over the last two months, with the 2009 target leading the decline. As of Dec. 5, the consensus projected the S&P 500’s per-share profits would fall 8% in 2008 and rise 9% in 2009. At the end of August, consensus estimates projected a 27% profit increase in 2009.

Your takeaway: Wall Street analysts have good reason to worry, and profit estimates seem likely to continue declining in the near term. Economic weakness and credit woes are taking a toll on all sectors of the market. Investors should ride out the storm with fundamentally strong companies that seem capable of topping expectations.

Investors
The best way to gauge investors’ opinions is to look at market action. When investors panic and sell stocks, the market falls. When investors are nervous, even good news may cause the market to rise only in fits and spurts, and stock prices will not reflect fundamental strength.

Over the last year, the S&P 500 Index has been unable to sustain upward momentum. The index has rallied in recent days but still trades at less than 17 times trailing earnings. At its lowest point in November, the index traded at 14 times earnings, a level not seen since 1990.

Your takeaway: Valuations don’t seem to matter in today’s market. But over time, as the credit markets firm and the economy gains traction, investors will realize that many stocks trading at six or 10 times earnings are a real bargain. Emphasize attractively valued stocks — there are plenty available — but have patience. Lacking some tangible, broad-based good news, stocks may have a tough time holding onto gains in the months ahead.


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