Earnings season is upon us once again, with a few companies schedule to release quarterly profit reports, revenues and their own forecasts in the coming week. By perhaps the best measure, the market has already priced in much of the current economic recovery: the current modified price to earnings ratio (PE/10) for the S&P 500 index is currently at 23.5x, which is 43% higher than its long-term historic average (Source: Hulbert Financial Digest.). So what you ask? The market has been overvalued by this much four times in the past 100 years: the top of the market in 1929 (just before the Great Depression), the mid 1960s (before a 16 year period of market stagnation and America’s run of hyperinflation), the late 1990s (just before the tech bubble burst) and yes, the top of the market in 2007 (just before the credit crisis and the onset of “the great recession”).
Will this time around be different?
So far, the markets themselves have been comfortable with these high valuations. If they weren’t, the market advance of the past six months or so wouldn’t have happened. With the Fed keeping interest rates artificially low, these equity valuations may be justified, and the current advance could very well continue for a long time. But take away the FED stimulus (as some in Washington want to do) and interest rates would be much higher than they are today, causing these high equity valuations to become more of a concern. In the end, if the concern becomes legitimate the market will reflect it.
Here’s our current view of the markets – our five-year ETF charts with both their respective short- and long-term trend-lines. All major market segments are currently in rising price trend environments, but as you can see several are weakening up a bit (large-cap growth, basic materials equities, and high yield bonds). Because the markets are still in the throughs of a rising trend, we’ll hold our current assertive posture until prudent action (and risk reduction) becomes necessary.