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No doubt, there’s been a rush into equities. The S&P 500 Index has doubled. It’s up 112%, in the last five years. It’s up 14.8% in the last year, 6.8% in the last six months, even up 1% this year after an early correction (and up 7.2% from that Feb. 3 low).
In recent months, the only thing that seems to be supporting these stock gains is, well, the stock gains themselves. There hasn’t been much in the way of fundamentals to support the buying.
Consider these developments:
On Aug. 8, the Wall Street Journal reported that stocks looked overvalued. “Stocks in the S&P 500 are at their highest price/earnings ratio in nearly four years, and above their average multiple of the past 10 years,” the Journal reported. Since then, the S&P 500 Index has risen 9.92%.
By November, Ben Inker, head of asset allocation at GMO, the investment company founded by widely- admired investor Jeremy Grantham, warned that “the U.S. stock market is trading at levels that do not seem capable of supporting the type of returns that investors have gotten used to receiving from equities.” GMO’s assessment: the S&P 500’s fair value was 40% the then-level of 1791.
Two months later, another report in the WSJ argued that the bull market was “long in the tooth.” Mark Hulbert wrote “For the S&P 500, the price/sales ratio currently stands at 1.6, which is higher than the comparable readings that prevailed at all but two of the 18 bull-market tops since 1955, which is how far back data are available.”
Today, the price-to-earnings ratio for S&P 500 companies is 15.3. That’s higher than the 5-year average of 13.2 and 10-year average of 13.8, according to FactSet.
Of course, these warnings of overvaluation may have overlooked expectations for gains. After all, investors buy when trends are pointing toward economic growth and, in turn, better corporate earnings.
But the supporting evidence for that thesis is lacking. Through Tuesday, 75% of the S&P 500 companies that have reported earnings that beat analyst estimates. But the earnings have risen just 1.5%. Also, just 19 companies have issued positive earnings guidance, compared to 53 that issued negative guidance, according to FactSet. And the news is worse for the Dow Jones Industrial Average companies. First quarter earnings for those companies fell 3.3% through Friday. If that number holds, it will be the third quarter in a row for year-over-year earnings declines.
Despite the lackluster results and tepid guidance most analysts are predicting a robust finish for the year. Analysts are predicting earnings growth of 7.8% for 2014, including double-digit (10% and 10.3%) increases for the third and fourth quarters, according to analyst estimates compiled by FactSet.
Such a move would require an enormous surge in growth that, despite the optimism expressed by Federal Reserve Chairman Janet Yellen on Wednesday, just doesn’t seem likely in an economy that produced an estimated 0.1% annual GDP growth in the first three months of the year. A boom in earnings growth will also be hard to attain when 48% of companies that reported through Friday fell short of analyst estimates for sales in the first quarter.
As I’ve noted before, the stock market reflects confidence, but it’s the confidence of mostly a few wealthy people, or, more likely, the brokers and financial advisers of a few wealthy people. Retail investors have joined the game late: they’ve been pouring money into long-term stock funds since the beginning of the year, after withdrawing in late 2013, according to the Investment Company Institute.
Some have argued that the persistence of ultra-low interest rates has made stocks the only game in town. History suggests there is some truth in that, but cheap money usually encourages home buying. In that realm, housing prices actually have fallen since September 2013 and nationally remain at 2004 levels, according to the S&P/Case-Shiller Index.
Commodities and other investments also haven’t come close the performance of equities.
No, stocks are clearly the investment of choice.
Maybe it’s greed: investors want to bet big on a wave of potential gains.
Maybe it’s fear: they worry about the prospects of other asset classes.
Or maybe it’s something different altogether: a rally built on rallying. Why not?
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