Confidence & the P/E

Everyone is very depressed. Investors are very depressed, as evidenced by the latest Bull/Bear Ratio, which is 1.06 this week. Although that’s the first reading above 1.00 in seven weeks, it’s still very low. Yet the S&P 500 is down only 2.3% ytd and 9.9% from the year’s high on April 29. Consumers are also very depressed. Yesterday, the Conference Board released October’s Consumer Confidence Index (CCI), which plunged during the month to 39.8 from 46.4 in September. It is the lowest since March 2009. The expectations component fell to 48.7 from 55.1 last month. Yet retail sales have been remarkably resilient.

There is a close correlation between the forward P/E of the S&P 500 and the expectations component of the CCI. They have fluctuated in volatile cycles since 2008, rising together in response to the Fed’s numerous attempts to make things better, but then falling together on disappointment over the results. Unemployment remains high. Inflation-adjusted incomes are stagnant. Home prices are depressed. Profits are great, but the European financial crisis increases the risk of a global slowdown or even a double dip.

Yet employment is growing, though at a lackluster pace. Home prices have mostly stopped falling. Energy prices are down from elevated levels at the beginning of the year. Borrowing costs are at record lows. Many business managers seem to be moving forward, and not letting the constant meddling of our political leaders get in the way of doing business.

The P/E rebounded during October as investors regained some of their confidence in the resiliency of the US economy. It also rebounded on hope that the Europeans would muddle along and avoid a financial meltdown. There should be more upside in the valuation multiple as long as investors expect that muddling will prevail over melting. That’s likely to be the case over the rest of the year. On the other hand, the upside for the P/E may be limited if consumers remain as depressed as they were in October. Are we having fun yet?