Insights & Advice

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Is the stock market too high?

At the end of the first trading week for November 2021, four stock market indices closed higher than two standard deviations above their 50-Day Moving Average (DMA; a moving average is a technical analysis indicator that smooths out daily price fluctuations). The S&P 500, the NASDAQ, the Dow Jones Industrial Average (the Dow), and the Russell 2000 simultaneously closed above those extreme overbought levels for the first time in 455 trading days (since January 16, 2020). This is where I tell you to batten down the hatches and get ready for a pullback, right? Not necessarily.

Historically, when this has happened for the first time in 12 months, all four indices have experienced better than average returns throughout the following year.

These four indices can have a lot of variation. For example, the Russell 2000 has gone kinda sideways throughout the last year while the NASDAQ has soared. In previous periods, the opposite has been true. During more extended periods, there is a tighter degree of correlation. However, it’s not often when those four indices simultaneously close at those extreme readings.

The Russell 2000 is the newest of the four indices, starting in some form in the 1970s. Since then, there have only been 11 instances in which those four indices simultaneously broke above their 50-DMAs (without having done so for at least a year). It sounds ominous, right? Not exactly. Keep in mind that a stretched market can get extended further. For example, according to information from Bespoke Investment Group (BIG), the indices have been pushed all the way to 3.55 standard deviations above their 50-DMA before turning down. Of course, others only achieved standard deviations of 2.23, 2.11, and 2.05. Nonetheless, in each instance, the S&P 500 was higher one year later.

(The returns of the other three instances were not dissimilar. The NASDAQ tended to have more negative returns in the short term, and the Russell 2000 was the only index with a negative return one year later.)

My emotional reaction to overbought conditions is to get more defensive. (Keep in mind, I’m one of the most conservative 48-year-olds you’ll find). However, sometimes historical context helps me, and hopefully you, to think more about the fundamentals than the fear.

Fundamentals over fear

I’ve been out for two weeks, trying to get smart at a conference and doing some corporate channel checks. I’ll ease us back into my nerdy deep dives. Today, I’ll offer some bullet points that suggest that the fundamentals are good enough that the above historical instances of strength begetting more strength are likely to repeat.

  • Vaccinating children should help get more parents back to work. As of September 2021, there were 800,000 fewer prime-age workers (ages 25-54) with children in the workforce compared to before the pandemic.
  • Despite higher inflation, holiday spending should be gangbusters. People with lower wages are seeing pay bumps, and people with higher salaries still have savings.
  • As of publication, President Biden intends to sign a $1.2 trillion bi-partisan infrastructure bill when Congress reopens (Congress is currently scheduled to be back in session on November 15, 2021). The bill includes $110 billion for roads and bridges, $66 billion for rail, $25 billion for airports, $55 billion for clean drinking water, $7.5 billion to build electric-vehicle chargers, $39 billion for public transit, $65 billion into broadband, and $17 billion into ports.
  • In every newspaper across the country, you can read about local town officials deciding how to spend their millions of ARPA (American Rescue Plan Act) funds.
  • Corporate earnings have been stellar. The forward price-to-earnings (P/E) ratio approached 27 at the end of 2020. The epic rebound in the E of P/E has brought the P/E down to 22. (Granted, that’s still high, but we’re dealing with an improving economy with decreasing valuations, which is a good combination).
  • The labor market was strong last month. The non-farm employment growth for October 2021 was a net 531,000 – better than the 442,000 average throughout the previous three months.
  • The Fed announced it would taper, and I was right that the stock market wouldn’t care. Because of its new repo facility, I argued that the stock market wouldn’t experience a “Taper Tantrum.”
  • U.S. Gross Domestic Product (GDP) is bouncing back this quarter. The latest estimate of GDP growth for this quarter is 8.2 percent.
  • The Port of Los Angeles has moved toward 24/7 operations, joining its Long Beach counterpart. This is an extension of the White House taking supply chain issues seriously, which should help tame inflation by late 2022.

I am not being a Pollyanna. I know that inflation is out of control and is a silent tax on spenders. I understand that a new COVID variant could be lurking around the corner. If the White House passes another spending bill into law, higher taxes could wallop the economy. But only one of those (inflation) is a current threat. And while I don’t suspect prices to drop, I expect that inflation growth will peak as supply chain issues get corrected.

I’d rather be in the stock market today than out of the market, figuring out how to get back in.

Allen Harris is the owner of Berkshire Money Management in Dalton, Mass., managing investments of more than $700 million. Unless specifically identified as original research or data-gathering, some or all of the data cited is attributable to third-party sources. Unless stated otherwise, any mention of specific securities or investments is for illustrative purposes only. Adviser’s clients may or may not hold the securities discussed in their portfolios. Adviser makes no representations that any of the securities discussed have been or will be profitable. Full disclosures. Direct inquiries: email hidden; JavaScript is required.

This article originally appeared in The Berkshire Edge on November 15, 2021.