Judgment Day

Well we got our rally and that is enough to switch the short term trend positive. Now it is time to see the follow through, however I don't believe it will be so easy. You have the 61.8% retracement and plenty of other resistance including the major broken trendline in most of the indexes. Any stop near the 61.8% retracement will generate a head and shoulders top. I don't want to get too excited about this pattern because it has already failed once in this rally since March, however this could actually give it the excuse to sell off. Too many people will be saying the head and shoulders didn't work then, it wont work this time either. Breadth is increasing but not nearly as strong as it fell and is appearing it will continue to diverge. Overall volume continues to be lower on this rally/retest.

SPX Earnings Estimates

Recently I hear all this discussion about the SPX being fairly valued because estimated EPS around $80 is not unreasonable. However if you look at the data above, the current EPS of the SPX is 49 while the current estimates are 62. The estimates for next year as calculated by Bloomberg is 78. Now, if our current EPS is 49, and the estimate is 62, doesn't that lead you to believe that an estimated EPS of 78 is a bit too high. That would require a 59% increase in EPS. I don't see how this is feasible unless I'm missing something here. It seems as if I am, at least I hope so.

I've applied those estimates to the chart above. I've calculated the average P/E ratio to be 16 and therefore have applied a 16x multiple to the earnings to generate a fair value for the S&P. By plotting this against the current price we can also try to compare which one the market appears to be looking at. If we go with actual earnings, our fair value is around 780, while using the estimated earnings would put us to around 1005. I'm not sure how credible this study is but it is certainly something to look at. It would appear no matter how you look at it we are overvalued based on EPS but due to extreme bullishness in the market, momentum has carried us well above fair value just as it carried us well below back in 2008.

Analyst Research
Another thing that I've recently thought about is the fact that analysts typically always have some sort of premium on their targets and more often then none their rating structure looks a bit like this:

• Buy: 60%
• Hold: 35%
• Sell: 5%

Obviously they are trying to make money and by issuing sell reports on every single stock they will generate no revenue for their firm. Everyone knows this but another thing I was recently thinking about is in relation to using price multiples to generate targets. These are great if the company is market is fairly valued, however what's not to say the market has been overvalued for 20 years. Most stocks only go back to the beginning of the bull markets and I don't think there are any that have data dating back to the 1930's. So if you try to find the average historical P/E ratio of a stock and apply an estimated EPS to find a target price, more than likely you're going to be giving an overstated stock price. I could come back in 10 years and laugh at how silly this is but I'm just jotting down some recent thoughts I've had.

Hochberg

Hochberg spoke on CNBC this morning very briefly. He is the guy who does the Short Term Updates from Elliott Wave International. They didn't allow him to say all that much and it almost appeared as if he was being ridiculed, but what I really thought was interesting was the user comment section on the news story CNBC posted on their webpage. You can find it here.

Here are some that I found interesting, and I hope I have their permission to post them on this blog:

"Anyone calling this a "bear market rally" just shouldn't be allowed to touch this market. I feel bad for the people that trust their money with the ones who believe this is a bear market rally. A bear market rally does not have higher highs and higher lows. A bear market rally does not last this long. Come on people. Wake up and smell the recovery."


"Anyone who believes that this was a bear market rally must also believe that we are going to go lower than the March lows. The March lows priced in dooms day. I just don't understand how any reasonable person can look at the charts and the fundamentals and say that this is a bear market rally. This person is mostly likely majorly short."


"I'd also like to know where you get 91% bulls? Every news item you see is about how this is a bear market rally and that the world is coming to an end. If you listen to people who know what they are doing and who have a proven track record such as Warren Buffett and Jim Cramer you wouldn't be fooled by the negativity of the fund managers who have an agenda."

These comments are a good example of the optimism that has been built into the markets. Not a single post agreed with him even though a year ago he had come on CNBC and had done a pretty good job of forecasting the move lower in the markets. The first comment just does not make any sense. I at least agree with the second comment on 2 things. A bear market rally does in fact mean we will see lows below March and EWI is in fact majorly short, in fact 100%. However I do not rule out the fact that this is not a bear market rally because the charts and fundamentals both tell me it certainly can be.The third comment is at least a bit reasonable, but the 91% shouldn't matter its the same survey that told us that there was extreme bearishness at the March lows. If it worked then, it should work the other way around. Also who is to say that Warren Buffet and Jim Cramer have proven track records? I think last year kind of proved these guys can be wrong too. Perhaps a few more years of the bear market will make people have their doubts.

Lastly I'd suggest you guys go and check out elliottwave.com as they are having a free week this week where you can read a lot of their material for free. Just sign up for a free club EWI account. Its certainly worth it in my opinion.