Market Commentary

Weekly commentary on recent stock market action, with a particular focus on technical analysis.

May 24, 2017

Scott Wren, Senior Global Equity Strategist

S&P 500 Feels Like it Wants to Move Higher

  • The stock market, while lacking momentum, feels like it wants to trade higher in the nearer term. Hope and some improvement in international fundamentals are helping but valuations are high.

What it may mean for investors

  • Resist the urge to chase stocks. While we are not calling for an end to the cycle, we believe there will be better buying opportunities later in the year at lower levels.

The stock market has been stuck in a relatively narrow range for more than three months. Specifically, the S&P 500 has been trading between 2325 and 2405 since the middle of February. More recently, since late April, the index has been trading almost exclusively at the very upper end of that range and has barely crawled into record territory on several occasions over the past couple of weeks. Daily trading volumes have been below average during most of the recent sessions. However, saying that, the stock market seems to have a bid, at least for now.

So what is keeping the market elevated near record highs? It certainly isn’t cheap valuations. The price-to-earnings ratio (P/E) has steadily climbed higher during this recovery and now stands at nearly 19 times our 2017 earnings estimate. A quick glance at our Baseline database shows valuations have not been this high on a P/E basis since the 2003/04 period when stocks were climbing out of the hole created by the implosion of the technology bubble. Over the last 20 years, the P/E has averaged 16.4 times.

What do valuations look like on a price-to-sales (P/S) or price-to-book value (P/B) basis you might ask? Well, the news there isn’t much better. Once again, a quick look at our database shows the current P/S ratio at the richest levels since 2001 and P/B near the highest levels seen since 2007. But it is not uncommon in the later stages of a cycle for the various valuation ratios to move well above historical averages. Remember, in most cycles monetary policy is effective. In other words, when the Federal Reserve lowers interest rates to encourage borrowing and spending, that is what actually happens—except in this cycle.

Some would argue that valuations are higher because the new administration running the country is more likely to push business-friendly policies like tax cuts and less regulation, which is creating enthusiasm about what the future might hold. We would agree that pro-growth policies have been proposed, but Congress also needs to play ball and cooperate or come up with better ideas that will extend the current expansion. As this strategist has stated before, Job One for the new administration and Congress is to figure out a way to extend the current expansion. Fiscal stimulus applied at a sufficient magnitude is what it is going to take, in our opinion. Consumer and business confidence have soared since last November’s election, but spending hasn’t as nothing concrete has made it through Congress. But right now, it appears that the level of agreement between our elected representatives and the new administration is dicey at best.

Fundamentals here at home continue to slowly improve. The domestic labor market is finally beginning to tighten, although the pace of wage growth has been slow to increase. Fundamentals abroad are also showing signs of life and adding to the earnings prospects of companies doing business overseas.

So hope and some improvement in the fundamentals seem to play at least some role in keeping the equity market at or near record levels. The market feels like it wants to move higher, but in the second half of the year, we think valuations and the margin implications of higher wages will create headwinds for stocks.

Risk Factors

All investing involves risks including the possible loss of principal. Equity securities are subject to market risk which means their value may fluctuate in response to general economic and market conditions and the perception of individual issuers. Investments in equity securities are generally more volatile than other types of securities.

Definitions

An index is unmanaged and not available for direct investment.

S&P 500 Index is a market capitalization-weighted index composed of 500 widely held common stocks that is generally considered representative of the US stock market.

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