Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.
With the earnings season just getting started, this is not the start to the week bulls will have been looking for, as the S&P 500 fell 1.3% on Monday, while the narrower Dow Jones Industrial Average (DJINDICES:^DJI) lost 1.1%.
Whether or not it was tied to today's performance, a presentation/report from David Kostin, Goldman Sachs' chief U.S. equity strategist, for the benefit of the bank's international clients on Monday struck a rather downbeat tone (which is highly unusual for a "sell-side" institution – you're better off looking cheery when you're trying to sell something).
Kostin suggested that the probability of a 10% stock market correction is two-thirds, which sounds a bit alarming until you learn that a 10% pullback occurred every 11 months, on average, during the past century (this fact courtesy of my colleague Morgan Housel).
All the same, things might not be "business as usual," as Kostin went on to observe that, on the basis of their price-to-forward-earnings multiple, stocks have only been more expensive during two previous periods: the technology bubble of 1997-2000 and a four-month stretch a decade ago. Indeed, the market's current multiple – 15.9 on Jan. 8 -- is a bit higher than it was at the peaks of 1987 and 2007 – hardly reassuring benchmarks.
No wonder the report states that "the forward path [of the S&P 500] will depend on profit growth rather than [price-to-earnings] expansion." Earnings growth is the premise for Kostin's forecast that the index can rise 5% this year. (There's that sell-side optimism!)
One stock that hasn't benefited from an expansion in its multiple for some time is former highflier lululemon athletica (NASDAQ:LULU), the purveyor of high-end yoga apparel. In fact, the shares have seen their price-to-earnings multiple cut by more than a third since the end of 2012, when it stood at just over 36. That process continued today, as the company revised lower its guidance for its fourth quarter ending Feb. 2, citing a "meaningful" slowdown in activity in January.
The warning was enough to send the shares down 16.6%. An overreaction? Quite possibly -- after all, the midpoint of the new guidance range for fourth-quarter earnings-per-share, $0.72, is just 9% lower than it was previously. Then again, shareholders are hardly disposed to give the stock the benefit of the doubt after the company has produced a string of negative surprises over the past year.
In light of Goldman's aforementioned report, the case of lululemon athletica illustrates that stocks that sport premium valuations could run the greatest risk of correcting; furthermore, earnings growth may not be enough to prevent or compensate for the downdraft. In the case of Lululemon, analysts expect earnings-per-share to grow 20% in the fiscal year ending Jan. 31, 2015. High-flying "story" stocks such as Twitter, Netflix, or Tesla could be vulnerable to the same phenomenon.
Fool contributor Alex Dumortier, CFA, has no position in any stocks mentioned; you can follow him on Twitter: @longrunreturns. The Motley Fool recommends lululemon athletica, Netflix, Tesla Motors, and Twitter and owns shares of Netflix and Tesla Motors. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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