Market leaves investors with a sinking feeling

Trouble signs include recent reports of rising defaults in the so-called “subprime” mortgage market — which consists of people who are stretched for credit even in good times. That has thrown cold water on hopes that the housing market is on the mend. The worry is that if the increase in defaults prompts lenders to tighten up on easy credit, the housing market — and the U.S. economy — could be in for a bumpy year.

“It is tempting to say that the worst (of the housing slump) is now behind us, but that would be premature,” said Patrick Newport, an economist at Global Insight in a note Tuesday.

Investor sentiment could get another jolt Wednesday, when the government releases a revised report on GDP growth for the fourth quarter of last year. Some economists note that data available since the initial report came out last month point to a sharp cut in the revised number.

A lot depends on whether the recent strong run in corporate profits continues. One common measure of whether stocks are trading at a reasonable price is the ratio between the earnings per share and the stock price.

The so-called price-earnings ratio for the stocks in the S&P 500 has averaged about 15.6 for the last 70 years. During the U.S. market bubble, that ratio doubled. Then, as recession took a big bite out of corporate profits, the ratio continued to climb. As recently as the end 2001, the S&P 500 price earnings ratio was 46.

Since then, as profits have improved, that ratio has backed down to the historical average,  meaning the stock price you’ll pay for a dollar of corporate profits is just about in the middle of the historical range.

Regardless of where the overall market is headed, the falling market indices don’t tell the whole story. As always, not every stock marches in the same direction as the overall index. So individual stocks may behave very differently than the market indices suggest.

Michael Chren, who manages the Allegiant Large Cap Value Fund, notes that the five biggest stocks in the S&P 500 index — GE, Microsoft, Exxon, Citigroup and Bank of America — are trading at about 13 times earnings.

“On other end of the index, the smaller mid-cap names are trading at extreme valuation,” he said. “So this is opportunity for people to move away from risky stocks into less risky stocks.”

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