To Everything There Is A Season {Part II}

Yesterday we discussed the possibility of a change of equity leadership from US equities to international stocks.  Today I want to discuss the US stock market.  The S&P 500, the most broadly watched indicator of US stock market performance has gained nearly 16% since our election.  It is also up over 26% since putting in a bottom last February.  It would not shock me if US stocks called a time out for a bit.  Here are a few things to consider.

 US stocks are expensive on an earnings basis, currently trading at something like 18 times consensus estimates.  That is not stratospheric and the multiple may be justified in an environment where interest rates stay low.   Also there is a possibility that we are about to see an explosion in corporate earnings if the economy stays strong and we get tax reform.  I've seen some estimates that corporate tax reform, if done properly and including some program for repatriation of corporate earnings held overseas, could increase earnings on the S&P 500 by as much as 8%.  However, the market has been rallying now for months largely on these sort of beliefs.  If we've learned anything from the health care debacle last week in Washington, it's that translating the President's campaign promises into policy is going to be harder than most might have hoped a few months ago.  Markets could easily take a wait and see approach to policy now and that could lead to a period of consolidation for stocks.  

Stocks are also extremely overbought by our work and have struggled to make headway since March began.  Even so, it also seems that everybody is optimistic about the markets right now.  If I guage things by "the party indicator" then I'd have to say people are maybe a shade too optimistic.  There is a hint of froth in the air that I haven't seen in markets in years.  This is of course anecdotal but if you pay attention you can see this is more than a local event.  Money flow data into stocks has been strong all year.   That is something more indicative of a market top.  Few were clamoring to buy equities last summer when fear over the British exiting the European Union was at its highest.  That turned out to be a pretty good place to be an investor.  However, you had to shake off a lot of uncertainty back then and stocks ended up climbing the proverbial wall of worry for a very nice gain.

Finally we are about to flip into the seasonally weakest period for stocks.  Anybody who has been reading me all these years knows that I place great importance on the seasonal patterns regarding markets.  You can read this from me on seasonal patterns for some basic insight on this topic.  Suffice it to say stocks in general and historically have faced a tougher road in the period roughly from April to sometime in the autumn.  Now obviously this pattern doesn't hold every year but it has worked in enough years since investors have tracked stocks to be historically accurate and something for us to be aware of.

Of course I have no idea what the future will bring and I'd say that a period where stocks consolidate the gains of the last year or so would be in many ways healthy.  It would dampen the speculative fever that has been quietly brewing and allow for earnings to catch up to the markets.  Also while  there are no guarantees, nothing seems to be indicative of the possibility a broader sell-off at this time beyond a typical correction.  Stocks can also correct by time, as in going nowhere for a period of time, as well as price.  However, a historical correction would have the potential to take stock prices down anywhere from 5-15%.  Being aware of such a possibility allows us to prepare different portfolio strategies or emotionally prepare clients against such an event.

I don't want the take-away from this to be that I have become bearish of stocks.  There are many reasons that I have discussed in the past why I am longer term positive on the markets and the economy.  But there are longer and shorter term patterns to stocks and we are always weighing the evidence when trying to discern market direction.  Right now we are in the pay attention mode.  Stocks are down a bit more than 1% from their highs.  Probability would indicate a higher likelihood of a struggling market or perhaps a slight correction but there is little real evidence of that yet.  It is also possible that stocks will toddle along for a few days or weeks before finding their footing and continuing the bullish advance.  But there is enough little subtle changes that make me think we should perhaps be ready for a bit rougher sailing than we've seen over the last year.

Back Thursday.

*Long ETFs related to the S&P 500 in client and personal accounts although positions can change at any time without notice or dissemination on any other form of electronic media.