Bull Looks Tired, But Still Has Legs

3/13/2017


Bull markets don't die from old age, so the Wall Street adage goes. A confluence of factors tends to trigger a downturn, which may include rich valuations, unrealistically bullish sentiment, or an economic shock. Based on the body of evidence, the current bull market still looks spry and could keep charging higher even if the Federal Reserve accelerates its pace of rate hikes this year.

The S&P 500 Index set a record high on March 1, pushing stock valuations to new heights. The average S&P 500 stock has a trailing P/E ratio of 23, above its 20-year average of 21 and near its highest level since January 2004.

But high valuations are rarely enough on their own to cause the market to slump. Recall that Alan Greenspan, former chairman of the Federal Reserve, expressed concern about elevated asset prices in his famous "irrational exuberance" speech in December 1996. Stocks then proceeded to march higher for another three-and-a-half years before the tech bubble burst.

That leads into a second factor, sentiment. At the moment, investor enthusiasm appears to be moderate. Just 39% of individual investors are bullish, down from 46% at the end of 2016, says the American Association of Individual Investors. But newsletter editors are unusually bullish. Investors Intelligence views bullishness above 55% as the danger zone, and sentiment has exceeded that threshold in each of the past 15 weeks.

Bulls say the strong economy supports their optimism. "The long-term fundamental outlook remains favorable," says George Dagnano of The Peter Dag Portfolio. "The market is ignoring the pessimists and all their horror stories. It keeps rising, reflecting an improving economy and higher earnings."

Analyst estimates are holding up well, with the consensus projecting 10% profit growth for the S&P 500 in the first quarter, which would mark the strongest growth since the third quarter of 2014. For the year, profits are projected to rise 11%, up from 1% in 2016. Still, that growth may already be reflected in stock prices. At 21.2 times estimated year-ahead profits, the average S&P 500 stock hasn't been so expensive since December 2004.

Admittedly, the recent rally is partially driven by anticipation that U.S. companies will benefit from lower taxes and regulations in a Republican-led Congress. There is some risk that the unorthodox tendencies of the Trump administration could delay or derail these plans. Trump's promise of a massive infrastructure plan could also face resistance within his own party. Moreover, the controversial travel ban already appears to be threatening U.S. tourism, reports Bloomberg. And with U.S. birth rates at historic lows, stricter immigration policies figure to cut off a crucial component of economic growth: a rising population.

Yet we cannot help but be encouraged by the general distrust about the current rally. The 2008 recession is still a fresh memory, and plenty of potential investors remain on the sidelines. If the market keeps chugging higher, their fear of missing out will eventually overtake their fear of market losses. And if more investors plunge into the market, the water level should rise for everyone.


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