Stock prices have risen without a meaningful correction (in excess of 10%) for over 2 years. Have stock prices grown to a level where irrational exuberance could spell a correction or even worse in the near future?
A term made popular by then Federal Reserve Board (FRB) chair, Alan Greenspan, irrational exuberance was his attempt at explaining the development of a bubble in internet stocks during the late 90’s. Irrational exuberance is when stock values grow without regard for the underlying earnings and revenue of a company. All companies have a reasonable value point with regards to their earnings (P/E). I figured the calmness of the above picture would be a good contrast to this topic.
As of September 5th the forward looking 12 month P/E of the S&P 500 is 15.60[1], while the 20 year historical P/E is 17[2]. So prices are appropriately priced considering values over the last 20 years. So when considering this one indicator current valuations on the stock market, while seemingly high, are actually still indicative of a buying opportunity.
Is this to say that a correction is not warranted? Of course not! The market has gone essentially unchecked for 27 months. There have been prolonged sideways periods at times that have muted growth, but no meaningful correction has occurred. I would say that P/E ratios (as one gauge) at least tell us that a recession in values would not be called for, but a correction…
A few things to watch as the year moves on would be:
- GDP for the 3rd quarter – With the unusually strong 2nd quarter (as a result of the weak 1st quarter), these figures may disappoint.
- Retail sales – A minor, but leading indicator of consumer activity (68.6% of GDP)[3], should this soften, so should GDP expectations.
- Federal Reserve Board (FRB) Tapering – The FRB program is sent to complete (uninterrupted) in October.
- Unemployment Rate – Perhaps more important to the FRB at this point is the under employment rate, which sits at 12%[4]. If we see considerable advancements on the unemployment front, this could trigger an earlier than expected rate hike by the FRB.
Domestic Data
US nonfarm payrolls only increased by 142,000 in August[5], ending what had been 6 consecutive months in excess of 200,000 jobs added per month. This set back could be viewed as a positive as it may hold off FRB action. Also, Manufacturing and Service PMI’s came in stronger than expected.
International Data
The European Central Bank (ECB) sprang into action announcing that it was cutting its key rate and committing to a €500B bond purchase program. Telegraphed moves that just came earlier than expected, likely due to quickly deteriorating economic data released for the EU.
A Ukraine/Russia cease fire helped to calm investor anxiety and likely recapture some losses attributable to the conflict.
China PMI Data released this week showed strengthening economic conditions in the second largest economy in the world. Non-Manufacturing and HSBC Services PMI came in at 54.4 and 54.1 respectively (In excess of 50 indicates expansion)[6].
Japanese wages increased at a healthy pace of 2.6% year over year[7]. While much of the data is attributable to bonus compensation, it still was enough to bring hope that their economy was not stalling.
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Always remember that while this is a week in review, this does not trigger or relate to trading activity on your account with Financial Future Services. Broad diversification across several asset classes with a long term holding strategy is the best strategy in any market environment.
Any and all third-party posts or responses to this blog do not reflect the views of the firm and have not been reviewed by the firm for completeness or accuracy.
[1] www.oppenheimerfunds.com
[2] www.jpmorganfunds.com
[3] www.jpmorganfunds.com
[4] www.mfs.com
[5] www.investing.com
[6] www.investing.com
[7] www.mfs.com