Systematic Relative Strength

The stock market doesn’t usually move in a straight line, and volatility doesn’t either. Volatility moves up and down—and lately we’ve been treated to a big dose of the up! As a result, clients are now extra interested in low volatility products. Before you go crazy and switch your entire portfolio around, consider the findings discussed in an article in Financial Planning:

…research conducted by ICON Advisers President Craig Callahan and C. Thomas Howard, professor of finance at the University of Denver and co-founder of ICON affiliate AthenaInvest, has shown that while higher- than-average weekly market volatility occurs concurrently with lower-than- average or negative returns, this phase is frequently soon followed by lower volatility and higher-than-average returns. Stock market conditions change through time, and recent behavior often does not continue into the future.

In other words, things change. Just when you are sure the market is in a permanent downtrend, away it goes on the upside. Volatility is no different. Periods of high volatility and lousy returns are often followed by low volatility and strong markets. (We’ve written some about volatility clustering in the past.) The table below points out that we’ve had several volatility clusters in the past decade, so maybe we are due for some kinder, gentler markets.

Source: Financial Planning/ICON Advisers (click image to enlarge)

Evaluating stocks based on fundamental valuations is… um…not an exact science, as pointed out by Bespoke Investment Group.

At a current price of $502.50, AAPL trades at 11.8 times this year’s expected earnings. The S&P; 500 now trades at 13.5 times earnings on a weighted basis, while the average P/E ratio of the 500 stocks in the index on an unweighted basis is 17.7 times earnings. Given the fact that AAPL has one of the highest individual growth rates of any stock in the S&P; 500, it isn’t too much of a stretch to assume that the stock should have a ‘market’ multiple. To get there, though, AAPL would need to rally to just under $574 per share, while an average P/E ratio would send the stock to $752 per share. Within its peer sector, the average stock in the S&P; 500 Technology sector trades at 17.1 times earnings, which would equate to $728 per share. While AAPL is a member of the S&P; 500 Technology sector, it is often considered one of the best retailers in the country as it boasts one of the highest sales per square foot of any chain. The average retailer in the S&P; 500 trades at 16.4 times earnings, and based on that multiple, AAPL would be worth $698 per share.

Bespoke then had a little fun with the following table–pointing out the price of AAPL based on some comparable P/E Ratios.

There you have it–AAPL should be trading anywhere from $459.8 (if valued at the same P/E ratio as INTC) to $17,947.80 (if valued at the same P/E as NFLX)!

I think we’ll stick to letting the market tell us what a stock is worth and then following the trends.

Dorsey Wright currently owns AAPL. A list of all holdings for the preceding 12 months is available upon request.