QUOTE OF THE WEEK
“Life is a process, we are a process, the universe is a process.” – Anne Wilson Schaef
TECH CORNER
Just a heads up. From a technical stand point, the S&P 500 has broken below it’s channel which could be a sign that the stock market “may” have hit the high.
Part of the process we use is technical analysis which is the use of mathematics. Ever since the Fed announced that they anticipate three more rate cuts this year, the stock market has been rising in a channel up and to the right. Last week the S&P broke through the lower band and has not recovered back into the channel. Since the beginning of April, the S&P is down -3.8% and since last Thursday, the S&P is down -2.8%. We still need confirmation but the last day of March could have been the top.
There are multiple reasons why but a big one is that the Consumer Price Index has started to re-inflate which could cause the Fed to re-assess the three rate cuts they announced.
Another reason is that the bulls are coming to the realization that this stock market is in the top 10 percent of valuations of all time. This is according David Rosenberg, who I follow.
The S&P is up 30% over the last year while corporate earnings are up only 4%. What doesn’t make sense is that the price earnings multiple (PE) has gone from 18 to 1 to over 21 to 1. In order for that valuation to be justified, corporate earnings should be up 45%. This market is reminiscent of the bubbles before 2000 and 2007. Markets don’t crash from a bad economy they crash from a good economy.
We are still in the recession camp and I know everybody’s saying it is going to be a soft landing or no landing at all. Trust me, the business cycle has not been repealed. Interest rates matter and higher interest rates work their way through the economy with lags that can sometimes last a few years. The Federal Reserve started a tightening policy in June of 2004. They were finished two years later. And then the bad stuff didn’t hit the fan until the end of 2007. That was the recession that no one saw coming.
Nine of the eleven sectors of the S&P are trading at PE multiples that exceed their long-term averages. Only two are trading below their historical multiples.
You could justify the multiples when interest rates were on the floor but interest rates are back up to where they were in the summer of 2007. When you normalize the multiple for the interest rate environment we are now in, the fair value multiple is 16 to 1, not 21 to 1. That is the extent of the overvaluation and the extent investors are over paying for the future earnings stream.
