Too Much Of A Good Thing?

12/5/2016


Propelled by robust economic data and optimism regarding policy changes in Washington, U.S. stocks trade near all-time highs. While a near-term pause or pullback would not surprise us, the primary trend is squarely in the bullish camp under the Dow Theory. Reflecting this week's upgrades, our buy lists have 89.2% to 91.2% in stocks.

Good news

Good news on the U.S. economy is not hard to find. Personal income and employment show healthy growth, helping fuel solid gains in consumer spending and gross domestic product. U.S. home prices have reached record highs, and consumer confidence has surged to its highest levels in more than nine years. 

According to Commerce Department figures, after-tax earnings for U.S. corporations rose 5.2% from a year earlier in the September quarter — the first increase since 2014 and the strongest growth since 2012. Consensus estimates for 2017 have edged higher in recent weeks, helped by improved expectations for the energy sector.

Moreover, President-elect Trump's proposals call for large-scale fiscal stimulus, something that has not been initiated outside of a recession in 50 years. Even without such stimulus, a reduction in the corporate tax rate could have major implications for corporate earnings and dividends.

Downside risks

The major risks, as we see things, are twofold. First, bullishness among investors has jumped, suggesting disappointment is possible if the economy slows or Trump's proposals hit legislative setbacks. Among those surveyed by the American Association of Individual Investors, the percentage of bulls recently moved to a 23-month high. Among newsletters tracked by Investors Intelligence, the bullish percentage recently jumped to the highest level since August.

Second, stocks look expensive. As shown in the table below, the median P/E ratio for stocks in the broad S&P 1500 Index is near 21 — higher than 97% of month-ends since 1994. Relative to historical norms, stocks still compare favorably to bond yields. But that could change if rising inflation triggers a sharp jump in bond yields.

For now, with the primary trend bullish and the outlook for profits improving, the weight of the evidence favors higher stock prices. But don't expect an uninterrupted advance, and keep an eye on bond yields.

Cheap stocks in short supply
--------------- % Of Stocks With Trailing P/E Of ---------------
0 To 10
10 To 14
14 To 18
18 to 22
Over 22
Or NM
S&P 500 (large-cap)
Recent
4
12
20
24
40
Norm since 12/94
8
17
22
17
36
Low since 12/94
2
5
9
3
14
High since 12/94
46
31
31
26
64
S&P 1500 (all cap)
Recent
4
9
17
23
47
Norm since 12/94
8
16
21
16
38
Low since 12/94
2
7
10
5
21
High since 12/94
41
28
27
23
58
         
S&P 500
(Large-Cap)
S&P
MidCap 400
S&P
SmallCap 600
S&P 1500
(All Cap)
Median trailing P/E
20.1
21.2
22.2
21.1
Norm since 1994
18.1
18.1
18.2
18.1
Recent as % of norm
111
117
122
117
% of month-ends lower since 1994
83
97
99
97

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