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Inside the Numbers Redux; Why We (Likely) Still Haven’t Bottomed

Posted on | November 18, 2008 Time: 8:49 am |

Warning - Ground May No Longer Be Under You...

Warning - Ground May No Longer Be Under You...

On October 23rd I put together some stats that I just couldn’t reconcile in a post titled “Inside the Numbers - Why We Haven’t Bottomed Yet“. I was running screens to analyze the relative performance of what I saw as the safest companies, specifically filtering the S&P 500 members for the following:

  • Earnings Stability - Forward P/E under 10
  • Cash Flow - Under 20x Free Cash Flow
  • Balance Sheet  - Debt/Equity under .5
  • Balance Sheet - Current Ratio above 1.0

Here were the results at the time, and why I left the exercise frustrated and thinking the true bottom had yet to arrive:

Running this screen on the S&P 500, only 66 stocks fit the criteria. These are all under-leveraged companies with ample cash flow to meet current obligations, and trading for less than a market earnings multiple. And in aggregate, they have underperformed the market in the past month:

86.4% (57/66) are down over 20% in the past month, 14 percentage points higher than the ratio for unfiltered stocks;

59% (39/66) are down over 30% in the past month, 15 percentage points higher than for unfiltered stocks.

The list of 66 is actually well-diversified amongst sectors, with every sector represented by at least 3 companies in the filtered list.

In a nutshell, here’s why these ratios didn’t tell a happy tale on October 23rd. The all-important sideline money - the big investors that had been mostly cash for months - simply weren’t dipping their toes into the market yet. If they were, we would see a lower than average percentage of bad performers within the “safety net” filter.

Margins of Safety

I fully accept that a large standard deviation is in play when viewing data like this, but the statistical underperformance of the “safer” stocks was so large that I had to deduce some trends were in fact manifest in the markets. The absence of any real buying from the long-focused investor capital left me feeling scared that there wasn’t enough to counteract the de-leveraging and otherwise forced selling in the markets.

No Difference Today?

I ran the same screen today, three weeks after the original incarnation. In that time the market has made another failed attempt at a rally, and we now sit 9.5% lower on our benchmark S&P 500.

I’m using a time period of one month for the relative performance, which is really just an attempt to capture some smoothness around the right here and now. With the VIX seemingly in long-term parking above the 50 level, we need to allow ourselves to step back and take snapshots of the market through a wider lens.

But year-to-date studies are too long, and hold little value; the proverbial slate was really wiped clean starting in the summer. Looking back at what any stock did in January seems like it would only throw off data, not add to its value.

Screen Results:

59 stocks in the S&P 500 pass through the filter, as of the November 17th close:

38, or 64.4% are down more than 10%, versus 58% for the S&P as a whole;

25, or 42.4% are down more than 20%, versus 32% for the S&P as a whole.

Parting Thoughts

While the performance gap has tightened a bit, it’s still not anywhere near close enough for me to feel confident about the market. Fundamentals are still being tossed out the window, as are the prospects for the re-entry of investors who actually look at those metrics. Whatever their independent reasons for staying at bay (there are plenty to choose from), until they become meaningful buyers again I just don’t see the equity markets moving higher.

Ryan Barnes

More on this topic (What's this?)
FABER: S&P COULD DECLINE 20% FROM HERE (THE PRAGMATIC CAPITALIST, 1/27/10)
Glenn Neely: Multi-month decline (All Allan, 1/22/10)
Emini S&P: Another Setup For A Rebound (Short-Term Trading, 1/30/10)
Read more on S&P 500 (SPX) at Wikinvest
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