Stocks: It’s Going to Be a Bumpy Ride
The post-election stock market rally has been exhilarating, but based on the empirical evidence it looks like we may have gotten ahead of ourselves. The forward P/E ratio for the S&P 500 is approaching 19 times estimated earnings, which is 20% above its historical average.
Higher P/E ratios are normal when interest rates are low, but with the Fed almost certain to raise rates later this month, the argument for higher multiples is losing strength. The average S&P 500 dividend yield of 2.1% looked comparatively attractive when the 10-year Treasury note was yielding just 1.6% only two months ago. But now that the same government-guaranteed security is paying 2.5%, some income investors may have difficulty rationalizing owning stocks.
The possible overvaluation of the stock market is also revealed by my IDEAL Stock Rating System. A few months ago I noted that the stock market was not overvalued based on the average IDEAL score of a 5.1 for the entire S&P 500 Index (on a scale of 0 – 10; higher is better); today it clocks in at 3.9 which is the lowest it has been since I started tracking it two years ago. That suggests we may see a pullback soon, which would be a normal response to an inflated market.
If we don’t get a correction, at best I expect the stock market to trade in a tight range over the next six weeks until we start seeing quarterly and year-end earnings reports that will either confirm or refute stock values. Coincidentally, most of those reports will be released within a week or two of Donald Trump’s presidential inauguration on Jan. 20, adding another layer of angst to an already stressful period.
The confluence of all these factors is pointing to a highly volatile first quarter in 2017. Even if we get through January without much damage, February and March will introduce Trump’s high priority policies that could roil the markets. As Trump has said many times, his negotiating tactics are based on misdirection and surprise, which may be his art of the deal, but which will rile the markets.
That means many of the assumptions affecting stock values now may change over the next ninety days. Although this uncertainty can be disconcerting, it can also be profitable. Investors willing to move quickly and capture short term price changes can be richly rewarded.
In anticipation of this type of market we recently introduced a new service, Systematic Wealth, which recommends trading opportunities with holding periods from one to six months. We also recently expanded Profit Catalyst Alert to take advantage of Linda McDonough’s exceptional options trading expertise. Just within the past two months Linda has closed out options trades gaining 69%, 115% and 326%.
And with heightened volatility on the way, I expect that we will see many more of these types of profit opportunities in the months to come.