Approaching a Tipping Point

On Thursday, June 19, the S&P 500 made it 66th new high of this bull market and unfortunately, based on almost any metric available, one could argue that the U.S. equity markets are due for at least a mild correction – or more. 

The current run 
Since the recent near-term low on 4/11/14, the S&P 500 is up at an annualized rate of 52.79% (4/11/14 – 6/19/14), pretty tough to sustain that for long. 

The Chicago Board Options Exchange Volatility Index (the VIX, a contrarian indicator) touched 10.34 on the morning of June 20, which is its lowest level of this current bull market (3/9/09 – 6/20/14) and well below its average of 20.56 over this period. 

The S&P 500’s price-to-earnings ratio (P/E) is currently 17.98, which is its highest reading in over four years and well above its 10-year average of 16.15. 

Time since a major pullback 
It has been almost three years since the S&P 500 has experienced a 10% correction. Add it all up and throw in some unrest and uncertainty in Iraq, rising oil prices and mid-term elections, and it would be pretty easy to support the bear case for stocks at least for the short term if not the longer term. However, despite this, and as we discussed last time, we still believe the U.S. equity markets have legs and that they will be higher a year from now. However, that is not a foregone event, in order for that to occur we will need some positive developments. Before we discuss one of those positive developments let’s address some of the bubble talk that has been churning about as of late.

Looking at gold we see it is around $1315 per ounce and despite a big jump up on June 19, it is still down about 31% from its September 2011 peak. What about the rest of the commodity space? They are down about 16% from their April 2011 peak. 

Though prices are up about 25% from their trough two years ago they still sit 19% below their peak set in July 2006 (Based on the S&P/Case-Shiller Composite-20 Home Price Index). 

There has been plenty of talk of a bond bubble and many strategists have already “died” on that hill. We do believe the trend for yields over the next couple of years should be up, but the move up will most likely be more gradual than consensus has led us to believe and involve numerous retracements. We would like to note the 10-Year U.S. Treasury Note currently sits at 2.63%, up 21 basis points year-over-year and 79 basis points below its 10-year average.

Yes, the P/E of the S&P 500 is getting a bit stretched at 17.98, but it still sits squarely below the peak of the last two bull markets. However, as mentioned above, we need to see some good things happen to keep this bull market alive and one of them needs to be earnings heating up again so we can bring that P/E down to a more reasonable and attractive level.

We have opined quite often that earnings continue to be much maligned during this bull market and that every time we roll into earnings season the doubters come out. We have not jumped into that camp yet, but we do believe we need to see a reacceleration of both revenues and earnings to keep this bull-run alive. In other words, we don’t believe an earnings season that comes in at consensus levels will be enough. We need to see a re-acceleration of both top line and bottom line growth and, based on commentary from companies and recent economic data, we do believe this will be the case. We won’t know for sure until July when earnings reports begin to come in (14% report the week of July 14th and 32% the week of July 21st), but we do believe this will be the catalyst to help drive stocks higher as this bull market continues to age. If earnings don’t re-accelerate that could definitely be the tipping point toward that much-discussed – and overdue – 10% correction, but we don’t believe it will be enough to begin the next bear market.

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information


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