Insights & Advice

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S&P 500 Enjoys best quarter since 2009

It was a quarter to write home about. All three indexes made substantial gains but the S&P 500 Index had a great quarter and its best start of the year since 1998. Will it continue?

Is the market a time bomb ?

In the short term the answer is a definite maybe. If you put a gun to my head however, I would bet that sometime in the second quarter we will have a correction. In April, if history is any guide, we usually see the peak in stock market performance. As the month progresses, investors begin to “sell in May and go away.”

Monday the market received its latest shot of adrenaline when Federal Reserve Chairman Ben Bernanke assured investors that the easy money we have become addicted to is still needed. That sent the S&P 500 to its best closing level in almost four years. Those gains were led by the same group of stocks that have defied gravity and have continued to make higher highs without thought to earnings, price or any other metric of valuation.

One particular darling of the market that begins with “A” (hint: one of these a day is supposed to keep the doctor away) has witnessed its market value increase by $172 billion in the last two months. That is equal to the entire value of a large, well-established healthcare and consumer products company with over a 100 year history. It now represents 4.4% of the S&P 500 Index and by itself is larger than the entire U.S. utilities industry.

“A” will have to sell $2.6 trillion of products and services over the next decade (amounting to 1.5% of U.S. GDP) to justify that valuation. That would mean that every person in this country would need to spend $750/year on its products for the next ten years. I remember a similar period in stock market history where valuations got this high and we all know what happened to the DOT.com party. Another indicator, the number of net new 52-week highs of stocks on the S&P 500 is shrinking from 280 in the beginning of February to 63 today. That should elicit some concern since the same index moved up from 1,345 to 1,408 during that time period.  Warning signs like this abound, but remember that markets can remain irrational far longer than you or I can remain solvent.

My sentiment indicators are still flashing amber as bullishness remains at historically elevated levels. If one looks at psychology, as it applies to market cycles, it appears we are on the other side of euphoria which is the top of the bell curve of investor emotion.  To the right of this euphoric top, the markets back and fill. We are in the complacency stage right now where most investors and market pundits believe that all we need do is cool off a bit before the next rally. What’s after that?

If the markets begin to decline anxiety sets in followed by denial, panic, capitulation and then anger. This week we had three down days in a row, which is about the most we have endured all year. Many traders were expecting the quarter to go out with a big bang as institutional buyers did some end of quarter “window dressing”. The opposite occurred and instead we saw some profit taking in the high flyers.   Historically, bull markets have averaged 39 months in length. If you date this one as beginning in March 2009, then this bull is over three years old. That means by the end of the second quarter, you should be wary of a market top. In addition, during the last 21 election years between March 1 and Election Day, the maximum correction has been a loss of 9%.

None of this is new information because everyone is looking at the same data. The question is when you decide to pare back. The greater fool theory applies less and less these days. Those who hang around to the last moment often find themselves with no one willing to buy their high priced securities. Don’t let that happen to you.

Posted in A Few Dollars More, At the Market