Stocks took a breather yesterday, falling a modest amount after more substantial losses on overseas markets. Over the past several weeks, markets from stocks to bonds to bitcoins to gold have all been rising simultaneously, suggesting cash has been moving from the sidelines. All this happened despite mixed U.S. economic data, rising terrorism overseas, and heightened political controversy here that could come to a crescendo tomorrow as former FBI head James Comey testifies before Congress.
As we have seen this week, when there is a simultaneous melt up, it can’t go on forever. Indeed, it almost seems like a mini-capitulation by sidelined investors that they are being hurt by staying out.
Certainly, the economic data shouldn’t be encouraging enhanced enthusiasm. Growth in the first quarter was only about 1%, and while some talk of 3% or better this quarter, the numbers so far suggest growth won’t be a lot higher than it was in the first quarter. We are still adding jobs and the unemployment rate continues to fall, but the pace of additions is slowing. Auto sales are slipping. Housing is growing, but lack of inventory and rising prices both provide headwinds. Retail stores are experiencing both declining sales and declining employment. President Trump’s stances on immigration and terrorism threaten to hold back travel to the United States this summer.
Despite this sour economic data, corporate earnings continue to grow largely related to growth overseas and a weakening dollar. Lower than anticipated growth has put downward pressure on interest rates (and upward pressure on long term bond prices). Gold could be rising as a result of rising political uncertainty, especially in the Middle East. Don’t ask me to explain price movements in bitcoin because I can’t. About the only thing I can say is that when speculation enters a very thin market, strange things can happen.
Complacency has a way of entering one’s mind when events are going well and no contradictory facts appear. Without much in the way of new economic data or corporate earnings coming, the ingredients for complacency are present. But so are ingredients for hesitation, including sloppy economic data, heightened political angst, lack of progress in Congress with the fiscal agenda, and high valuations. Just one trigger can change complacency to hesitation to caution. Stocks have had a pretty good run in recent weeks. While there are no signs the bull market is over or that euphoria has become entrenched in equity markets, we are all becoming rather accepting of higher valuations than we have seen in about a decade. 20+ times earnings isn’t a historic norm. It happens late in market cycles often. As I frequently point out, P/E ratios tend to rise throughout bull markets, before sharply correcting when bear markets take over. They rise slowly and fall quickly. The best protection is to keep to your asset allocation and take some money off the table periodically to rebalance.
Now that names like Alphabet# and Amazon have crossed the $1000 barrier (and note that Apple# would have a long time ago if not for a 7-for-1 split), the question is what’s next? Can $2000 be far away? That is some of the crazy talk that begins to creep in during these runs. This isn’t 1999 when talk of every cocktail party was about the stock market; today’s conversation is more likely to be about Donald Trump. But periodic corrections are needed to create new attractive buy points, just as retailers use sales to boost traffic and move merchandise. Few are looking for a correction now amid the absence of bad news. But that is just the time to be careful. I am not suggesting anything more than rebalancing at the moment, but I certainly don’t believe now is the time to chase stocks that have just completed extended moves.
Today Allen Iverson is 42. VP Mike Pence is 58. Tom Jones turns 77. Prince would have been 59 today.
James M. Meyer, CFA 610-260-2220
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