Are PE Ratios Too High?

Tonight we see the end of the month of October is just past the weekend so there are only three trading days left.  As heavy as the market is trading right now, I will be surprised to see much in the way of upside in the next three days.  (famous last words probably)

The bond market is certainly showing signs of fatigue after the Bernanke announcement and there is now some speculation that he is going to have to come out with guns blazing in order to calm the fixed income market.  His easy money policies will not cut it there; and, to the extent higher rates will naturally cause less borrowing from home owners, the tough talk will need to be backed up by firm actions.

Thanks to Erick who points out a “connect the dots” article from JPM on one of the effects of the higher short term interest rates, that being lower stock valuations.  To see his comments go back to the comment section in yesterday’s post.  The gist of the article is that higher savings rates will be strong competition for stocks that have not performed very well with dividend yields that are very low too.  Thanks for the info, Erick.

My take on the situation goes back to the conversations about the market being in a new PE ratio environment.  The argument has been for many years, including the period surrounding the highs in the market in early 2000, that lower interest rates allow stocks to carry higher PE ratios.  Put a little differently, lower interest rates mean that stocks can trade at higher prices all other things being equal.  We’re finally seeing commentary that will lead us back to a normal PE ratio in the market.  In fact I firmly believe that we will see very low PE’s in the market as we proceed down the bear market path.  The market just needs to figure out how to start selling and when it does, it will go down much easier.

Today’s market was fairly dull but there was some interesting action early in the day.  The Dow Industrials pushed up to challenge last week’s highs just over 10,400 but fell back by the end of the day to close well under 10,400 at 10,344.  We remind you that there is a significant resistance point right over head for the Industrials, you recall the days and months that we have traded near 10,500.    

To be fair, the NASDAQ averages and the SPX have run above their highs from last week, but the early October highs are still in place not to mention the September highs and the August highs which are also in place.  All of these marks represent overhead resistance and we remain bearish against them.  

The article in the Wall Street Journal tomorrow, October 27, page A3 tells of Anheuser-Busch’s 24% drop in third quarter net income and how they have lowered guidance on 2005 earnings for the fourth time.  The beer business may suffer more if average Joe’s need to spend their money on heating their homes this winter or filling their SUV’s with gas.  Usually beer sales hold up in a recession, maybe not this time, we’ll see.  Anyway, just thought you’d like to know.  And, I see the Chicago White Sox just won the World Series (you have to go back a long time to find a Chicago team that has won the World Series) so there will be three less games to bolster those beer sales.  

The other news is in the political arena which we normally don’t report due to its lack of market impact but with the VP’s office being scrutinized there are possible reverberations in the stock market.  We don’t know what will cause the market to drop but so far the market has not been too strong through October and that should continue for several more weeks.  The market has too much bullish enthusiasm without any reason for it.  The news is normally sold whether it’s good or bad, with the possible exception of GOOG.  Be careful out there.  

Dow Industrials:  10,344.98  -32.89
RYVNX:   21.39
TLT:  89.28   (this hurts even though it’s only 1%)