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Some Thoughts On Stocks

Points to consider with stocks hovering around all-time highs:

  • Fed resized 600A friendly Fed has kept short-term interest rates near 0%, and the Fed has continued to buy long-term bonds with an $85 billion per-month plan intended to keep interest rates low. This has pushed borrowing rates for companies down, and also pushes investors into stocks and away from low-yield bonds.The Fed's plan all along has been to get asset prices high (stocks, bonds, real estate) so that consumers feel better and will, therefore, spend and borrow more to help the economy.  The problem is, in doing so, they have created one of the greatest stock and bond bull markets in one of the weakest economic expansions in history.
  • But when the S&P 500 has gained at least 20% through October, the momentum has usually continued through year-end (12 of 14 cases), with a median gain of 6% in the final two months.

That said, after a 4 1/2 year bull market run, investors need to be wary:

  • Retail investors are beginning to buy stocks in droves, a contrarian indicator.  Investors have poured $24 billion into equity mutual funds in the last three weeks, the third highest level since weekly data began in 2007.
  • Sentiment indicators are not perfect in runaway momentum moves, but they can help you be objective when most others are fearful or, as in this case, optimistic.  Following the crowd at extremes would have lost you over 10,000 S&P 500 points since 1995. And while extremes can only be determined for certain in hindsight, research indicates that the crowd is always wrong at extremes (see chart below).  At the current time, we are close to an extreme in optimism. This suggests that the risks on the upside have risen, and a time-out from the ongoing bull market is likely.

sentiment

  • The chart below indicates that stocks are 24% overvalued.  If earnings growth does not materialize, stocks could quickly approach their upper limit.  
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  • And there is a growing disconnect between the S&P 500 (blue line below) and the percentage of S&P 500 companies with positive earnings surprises (red bars).
earnings surprises resized 600
Charts courtesy of Ned Davis Research 

Stacey WallAlways remember, the big money in stock market is made on the big moves.  And consistency comes from reducing exposure during significant declines.

Stocks remain in a bull market until proven otherwise. Momentum is still positive and the Fed still friendly, so we continue to lean mildly bullish. But with investor sentiment nearing an optimistic extreme, we are watching closely.

Stacey Wall serves as President & CEO of Pinnacle Trust.  You can reach him by emailing him at swall@pinntrust.com or by calling him at 601-957-0323.