After a 5.4% gain last week, the strongest weekly performance since the week ending July 17, 2009, we are seeing stocks sell-off a bit this morning. The S&P 500 has rallied from a recent intraday low of 1,263 to 1,339 at the end of last week, which is a 6% gain. The problem I see is that investors still believe that the economy is recovering robustly, based on the previous (and some remaining current) economists and analysts overly optimistic growth estimates. Based on this incorrect assessment, anytime stocks sell-off, investors, again believing they are cheap based on these aggressive growth estimates, jump in, buying stocks back up. They seem to forget everything that is wrong with the world economy, as if it has simply disappeared. Unfortunately, these problems persist. More importantly, the growth estimates that investors are basing their purchase decisions upon , are, in my opinion, grossly over-optimistic. Since the earnings expectations for stocks are in part based on the growth expectations for the economy, earnings estimates are also grossly overoptimistic.
As we enter the second half of 2011, I believe analysts and company management teams, will be forced to lower their lofty earnings expectations, to more accurately reflect the real growth in the economy. This will force a realignment of stock valuations, bringing stock prices down. Given the volatility in the markets of late, we will very likely see stocks sell-off very hard, once the investing public realizes how overvalued the markets are at present. Investor overreaction will likely push stock valuations far below fair value, causing even more selling as investors panic out of stocks. While this action in the market will probably shake investor confidence, it will also offer an attractive buying opportunity for those with cash reserves and a well-conceived game plan.
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