Today, February 21, the Dow Jones Industrial Average, the Standard & Poor’s 500, and the Russell 2000 each hit new record highs.
As of Friday February 17, the &P 500 had already climbed 5% for 2017.
But valuations do look stretched. The forward price to earnings ratio standards at 17.6 times projected future earnings for the stocks in the S&P 500 index. That’s above the average for the past 20 years of 17.2 times forward earnings per share, according to FactSet. And the highest the forward PE has been since 2004.
But enough folks have missed the surprise post-election Trump rally and its continuation in 2017 that the first break in this market is likely to be shallow as money now on the sidelines moves to get in on the rally at “bargain” prices. That cash is now just waiting for the first dip to buy. Mutual fund cash positions have reached an average of 5.6%, according to Bank of America Merrill Lynch. That’s the highest level since November 2001.
If past history serves as a useful guide here, those cash positions and the fact that this rally caught a significant percentage of investors and fund managers by surprise, means that a lot of cash will treat the first dip as a buying opportunity. What this usually means is that the market will have trouble moving more than 3% or 4% lower because at that level cash-rich buyers will come off the sidelines. Think about your own sentiment: How many times have you said to yourself “I’d buy XYZ if only it were a little cheaper.”
I think it will take some big reversal in one or more of the underpinnings of this rally to turn any first dip into a real 10% correction. That means much worse than expected earnings–and Wall Street analysts have lowered their projections for first quarter 2017 earning per share to $130.31 for the stocks in the S&P 500 from $131.02 in early December–or a real scare on the debt ceiling or the vote to keep the government open, or real disappointment/worry over the Trump/Congressional tax plan. My timetable on that sort of bad news still points to no earlier than March. Then factor in some time for any bad news to hit market consciousness. Will April be the cruelest month?