Tabell’s Market Letter – January 30, 1976

Tabell’s Market Letter – January 30, 1976

Tabell's Market Letter - January 30, 1976
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TABELL'S MARKET LETTER 909 STATE ROA.D, PRINCETON, NEW JERSEY 08!540 DIVISION OF MEMBEI'I NEW VORK STOCI( eXCHANGE, INC MEMBER AMERICAN STOCK EXCHANGE January 30, 1976 We have noted in this letter the central technical fact that the stock market has remained, for the past Jozen years, in a trading range with a ceiling around 900-1000, DJIA. More recently, we have focused on whether the current strel'lgth represents an upside breakout from that range. Our long-time friend and vetI—lf–o–'efa'r;'-fnvestriie-rit advisor; Gleri-CatererC ha's, -cogently' in our'vlew examined the sam question from fund amental paint of view and has kindly permitted us to reproduce his thoughts below. A. W. TabelJ As compared wlth past periods of assault upon Dow 1000, price-earnings multiples this time around are historically low. This relative must be appraised on the basis of earnings quality, the earnings trend and competitive interest rates. It is difficult to determine a proper PER. History is not very helpful; conditions have changed too much. Prior to 1929, with a 5-6 bond rate and little inflation, an average price-earnings multiple of 10 was widely accepted as normal. The depression, the New Deal, elimination of the interest rate as a compet- itive investment factor, and the World War changed all that. Then came the early 1950's. The ease with which we emerged from the post-war recession, the effect upon inflation expectations of our further move into the world arena via Korea, and the mushrooming of institutional investment in equities established new bases for the valuation of common stocks. And now these bases probably have been destroyed by the fi- nancial strain brought about by the persistence of inflation at unprecedented peace-time rates. Thus the price-earnings multiples of 17 on four previous occasions when the Dow-Jones Industrial Average attempted to penetrate 1000 are not relevant to the discussion of multiples today. In addition to the depressing effect of high bond yields,a question exists as to the quality of the earnings being capital- ized. In 1966-71, when earnings on the Dow averaged 55, the average rate of return on net asset value was 10.5, with a definite downward trend. At the end of 1972, when the PER was 13, down from 17, the rate of return was 12; in October 1973 the PER was 10 and the rate of return was nearly 14. Nevertheless, the PER of 12 last July on earnings down to 9.5 on net assets, and, if the estimates are correct, a recent PER -'- -of l-l-on an-earnings-returwof-l0-.5-seem-to be low by recent-standards.-And a'PER-of 10-on-earnings-of–!—- 12 on book, again if estimates are correct, seems to be modest. And so, to this extent at least, the case for strength continuing beyond 1000 this time is better than, in retrospect, in the past. The ability of the Dow to approach 900 in mid-1975, the first time this has been done when earnings were in a definite recession is probably an indication of the underlying pull of value, and augurs well for higher prices if and when earnings are in an uptrend. In the past ten years, the Dow book value has gone from 453 to around 800, and price-times-book from over 2 to a little over 1. The remaining factor, interest rates, is as important as earnings quality in influencing the PER. But how to explain PER's staying at 17-1 while yields on high-grade bonds mounted from under 5 to 8 The answer probably is intellectual lag on the part of stock-minded investors (which may be operating in reverse now). It is also probable that not until 1970 was the meaning of the meteoric rise in interest rates appreciated. It doesn't lend itself to useful econometric analysis, but even if a stock multiple of 16-17 (earnings re- turn of 6) is not commensurate with long-term interest rates of 7-8, an earnings return of 10-11 is supportable in the face of a long-term rate of 9. Assuming then that stocks are modestly valued, the case for higher prices rests upon whether the in- fluences upon them are going to become more or less favorable. These influences are predominantly earn- mgs and.mterest rates. The consensus is that this year earnings will rise, maybe by 25 or more. The Significance is somewhat reduced because these represent recovery rather than an ongOing trend. A major- ity, if not a consensus, also looks for decline in interest rates. This is the more significant influence and it is not invalidated if earnings do not improve as much as estimated. Of course, unforeseen events such as war, liquidity criSiS, and pessimism about 1977 could invalidate -n-. the thesis. As-to each of these, categorical answers wouldrbe uselessi if,not worse. Of coursei-there afe always uncertainties of one kind and another; if it weren't so there would be no point in investing for capi- tal gain. If stocks are indeed relatively low m price, that offers some protection – it tilts the risk-reward ratio in favor of the holder. Thus, those circumstances that lend themselves to conventional market analysis appear more favorable than at any of the times of past assaults upon Dow 1000. Valuations are more conservative, earnings re- covery less advanced, and stocks are again competitive with bonds, the Yields on which appear to be declln- ing. It would be surprismg if the Dow, on this move at the beginning of the year should continue on through 1000 without consolidatlDn or reaction. But the case for penetration sometime this year to a new and higher area of price appears to be a strong one. Dow-Jones Industrials (1100 a.m.) 977.09 S & P Camp. (1200 p.m.) 100.91 Cumulative Index (1/29/76) 572.18 GLENELG P. CATERER, CFA AWT/jb No statement or expression of opinion or any other molter herein conta.ned IS, or .s to be deemed to be, dHeC'!ly or indirectly, on offer or the sol,c,tot,on of on offer to buy or sell ony security referred to or mentIOned The motter IS presented merely for the converlence of the subscriber While -Ne believe the SQurces of our mforma tlon to be reliable, we In no way represent or guarantee the accuracy thereof nor of the statements mude herein Any OC'!lon to be token by the subscflber should be based on hiS own investigatIon and 'nformatlon Janney Montgomery Scott, Inc, as a corporation, and Its officers or employees, may now have, or may later toke, poslhons or trades In respeC'! to any secUrities ment,oned In thiS or any future ISsue, and such pOSlhon may be different from any views now or hereafter expressed In thiS or any other Issue Janney Montgomery Scott, Inc, whICh IS registered With the SEC as on mvestment adVisor, may give adVICe to Its Investment advisory and othel customers Independently of any Iatemenh mode 1M thiS or Hl any other Issue Further information on any security mentioned herein is available on request

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