Concern about an effective European bailout has decimated U.S. investor sentiment, causing them to ignore an earnings season that shows stocks offer a great value right now, some traders and strategists are starting to say.
The worst-case scenario right now is “waking up to news that European policymakers have run out of time to develop a rescue plan for their financial system,” said Nicholas Colas, chief market strategist for ConvergEx Group, in a note. “Stocks are still cheap, even if every bear on every name has it fundamentally correct from an earnings standpoint.”
On average, 60 percent of companies in the S&P 500 are beating earnings estimates since the third-quarter reporting season began this month, according to Bespoke Investment Group. Numbers for revenue are coming in even better.
Yet, the average stock price move following each of these earnings reports is a 0.4 percent drop, according to Bespoke.
“We are in a no man’s land whereby valuations are cheap, but macro-economic concerns continue to dominate the investment landscape,” said Alan Zafran, partner at Luminous Capital. “Burning garbage and steams of demonstrators in downtown Athens give me less confidence that my shares of Fifth Third Bancorp , Google and Intel Corp. are going to move sustainably higher in the near-term.”
The negative headlines from across the Atlantic caused investors to yank money out of equity mutual funds for a fifth straight week, according to the Investment Company Institute. Investors pulled $7.5 billion out of stock mutual funds for the week ending Oct. 12, more than the $3.9 billion outflow during the previous week.
Work by ConvergEx's Colas shows that investors are bailing at a time when stocks may be way undervalued. The strategist calculated a price-earnings ratio using the single lowest earnings estimate from analysts for key companies such as Apple and Pfizer . Even after using the estimates from the biggest bears on Wall Street, the market has a multiple of just 12 times for 2011, still historically low.
More investors may have started to come to this realization on Friday. The Dow Jones Industrial Average jumped more than 200 points at one point on better-than-expected earnings from McDonald’s .
“There is nothing in this earnings season so far that supports a U.S. recession,” said Michael Murphy, managing partner at hedge fund Rosecliff Capital. “Although the European headlines are making for a wild ride, lets remember the market is cyclical and this European financial crisis will pass. We are a lot closer to the end than we are to the beginning.”
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