There is little economic justification for the sell-off in the stock market. The sell-off is attributed to one thing, computer program technical trading. With the absence of an uptick rule to short stocks (along with traders not borrowing shares to short) shares continue to be sold off at historic volume levels. To support my position for why this is not justified, just look at the fundamentals. Stocks are and always will be priced based on their earnings and their expected earnings. After the close of the market today, August 10th 2011, stocks were 35% undervalued, based on next yearâ€™s earnings forecast. Further supporting the case for buying stocks now is oil prices and investor sentiment dropping. (Click to see the attached chart)
The downgrade of US Credit will prove to have no financial impact, short term or even long term on US equities and equity valuations. At this moment, there is nothing an investor should do. I am upset, as you should be, by how traders are scaring small investors by whip sawing stocks up and down with great velocity on an hourly basis. Very soon we will see a short squeeze (a short squeeze is when investors buy back shares that they sold without owning. Short selling is a very common practice when investors are looking for a down move in the market.) When this happens, donâ€™t be surprised if the headlines read â€śDow Jones up 700 points in one day.â€ť
In 1987 stocks were 40.2% overvalued and the selling was fierce, but somewhat justified. Program trading also contributed to that correction. The current 16% correction in the market began when stocks werenâ€™t even overvalued. Two weeks ago stocks were 7% undervalued based on next yearâ€™s earnings. As I stated earlier, stocks are currently 35% undervalued. I cannot give you a logical explanation, nor will I attempt to explain why we are at current levels. There is absolutely no rational explanation.
I cannot tell you when stock valuations will rise again, but I assure you they will very soon. I believe it wonâ€™t be too long from now until the Dow is at 15,000. I can support and justify that with facts. I cannot support nor justify the recent stock market action.
Please click here to read a supporting article from the Associated Press regarding program trading.
Ed Butowsky is the managing partner of Chapwood Investment Management and is an internationally recognized expert in the investment wealth management industry. Ed is also a frequent guest on other networks such as CNN, NBC, ABC, Fox News, Fox Business, and Bloomberg to name a few.
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