If you feel like the financial markets have been off to an unusually strong start to the year—you are correct. The S&P 500 Index has risen for four consecutive months, resulting in the strongest start in more than 30 years! To be fair, the early gains included recovery from oversold market conditions in December, but a steady combination of monetary policy, economic performance, and corporate profitability have pushed the S&P 500 to record levels.
While investors should be pleased with the new highs, it’s also important to keep an eye on what could temporarily disrupt solid market performance. There are three key areas that should remain in focus when making investment decisions and they include: fundamental analysis, technical analysis, and an assessment of the market’s overall valuation. The current fundamental and technical analysis of the market, along with its valuation, suggests that there is longer-term opportunity in stocks, but that opportunity will most likely be met with short-term volatility and even, perhaps, a healthy pull-back.
From a longer-term outlook, market fundamentals remain encouraging. U.S. economic data has been steadily improving in recent months, with signs of stabilization in manufacturing and gains in employment, personal spending, and business investment. In addition, the Federal Reserve appears to be set on keeping interest rates at current levels for the foreseeable future, which is allowing interest rates on loans and fiscal tailwinds to help support domestic economic activity. This continues to be a healthy offset to concerns of slowing growth in foreign nations and emerging markets, global negative interest rates, and an unsettled U.S.-China trade deal that remains squarely in the spotlight.
Technical analysis uses market sentiment, stock price charts, trading volume patterns, and moving averages to determine the overall health of the market. Currently, these technical metrics are showing solid momentum, positive trends in the charts, steady volume and the moving averages continue to show potential further upside. Moreover, in a recent industry survey, it was found that investor sentiment currently contains a healthy balance of both appreciation and skepticism regarding the recent market gains and that is encouraging because balanced sentiment, from a technical standpoint, creates neutral psychology in the market – we’re not too bullish and we’re too bearish. Also, although the S&P 500 recently hit new highs, it took more than six months to exceed its previous record set last September and historically, from a technician’s standpoint, when the S&P 500 experiences a six-month “pause” between records, returns over the ensuing 12 months have been above average. That said, if the technicians are on point, it would indicate good news for the markets over the next year or so.
When considering the market’s valuation, there are numerous measures that can be used to determine whether multiples are frothy or if the market looks cheap. Many investors look at the “price-to-earnings ratio” or put simply, the “P/E ratio” when evaluating the markets. The P/E ratio is determined by dividing the market’s current price by the current aggregate earnings of all companies in the index and, historically, the average P/E ratio typically ranges between 15 and 18. Currently, the S&P 500’s P/E ratio is around 21 which, to most investors, appears high and it would mean that the market is slightly over-valued, right? Well, if we dig deeper into other aspects of the P/E ratio calculation itself, many research outlets are now looking at P/E ratios relative to the current level of interest rates and inflation which, as the market is touching all-time highs, are at historic lows. When factoring low rates and low inflation, the market, despite being slightly overvalued, still remains attractive compared to interest bearing alternatives like bonds or CDs and with a friendly Fed, as mentioned above, stocks can accelerate longer-term to even higher levels.
It’s been quite a run for equities in the first four months of 2019 and, although the longer-term outlook based on fundamental and technical analysis and the fact many investors are looking the other way from slightly elevated valuations because of low interest rates, it certainly doesn’t mean that a pull-back in stocks unrealistic over the near-term. As we have mentioned in our most recent posts investors need to use discipline and a responsible approach to investing when building portfolios and always, always remember that complacency is never a strategy.
At Capstone, we have been adjusting client portfolios in response to the move so far in 2019. If you have any questions about your portfolio please give us a call. We can be reached at (570) 587-7800 (Office Direct) or at (888) 587-7526 (Toll-Free).
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.