The economy is finishing its eleventh year of continuous expansion with virtually full employment, no overheating and excellent levels of consumer spending and optimism. Stocks often move months in advance of earnings and GDP trends and currently appears priced for perfection and better growth ahead. The benchmark SP 500 Index rose a stellar 28% in 2019 while its underlying earnings fell, thus the market is pricing in one heck of a rebound in revenues and profits in 2020. We continue to be a Bullish into 2021, yet record investor optimism and stock prices moving far ahead of their underlying forward earnings typically indicates that sideways to lower price action is needed for the economy and earnings to play catch-up. Having conviction that the Bull will continue without a Recession long term doesn’t trump discipline in a richly valued market that warrants hedging for a pullback. The stock market is quite vulnerable to bad news events and the short term risk is rising over the Chinese Coronavirus escalation this week. Furthermore, we have been highlighting for weeks in interviews, newsletters and updates that today – January 24th – is an inflection point for a possible selling wave to kick off. We may be able to hold back the Corona scare and flash an all clear sign if this virus fails to become a global concern over the next week, but caution near our 3340 SP resistance in late January is warranted.With technology equities increasingly dominating the stock market, earnings become less important compared to sales and momentum for investors and managers. Analysts seemed to invent Price to Sales (PS) metrics to justify higher prices once the traditional Price to Earnings (PE) measure had become too stratospheric to rationalize Buy recommendations. However, even using the alternate Revenue or Sales metric, it’s worrisome that the stock market PS multiple continues into uncharted territory. The PS ratio has now surpassed the important twin peaks in January and September of 2018 prior to sharp market corrections. Even the tech bubble peak of 2000 has been overcome. How high is too high? No number is absolute even as valuations become more extreme historically, but the market is certainly more vulnerable to negative news events.
The more traditional metric of market valuation we referred to above is represented by earnings multiples. While many look at current or trailing Price to Earnings (PE) ratios, we prefer forward estimated earnings. Similar to the PS ratio, the forward PE has also surged to new record highs for this 11 year old Bull market at 18.6. To reach the nose bleed levels of the 1990’s tech bubble there is still plenty of room, however these elevated levels make the current market ripe for a negative news surprise.
What possible trigger will scare investors? While our timing indicator calling for a top on the 24th has coincided with new global virus fears today, we would place the Chinese Coronavirus as the top near term trigger risk for lower equities. However, for perspective, Corona has resulted in just 40 deaths so far compared to an average US flu season that kills almost 40,000 people without any alarm bells. The death toll in China is likely to rise into the 100’s quickly. While the World health Organization (WHO) may change its calm stance next week and declare this virus a high risk globally, it’s premature to assume the next pandemic has begun. Certainly news of Coronavirus deaths outside of China or a higher risk assessment by WHO would send global equities sharply lower along with the commodity markets as market move sharply on fear expectations. These pandemic scares are almost always overblown. Be alert for a higher Dollar, falling Oil, Copper and Bond yields that would signal increasing risk to stock valuations. Any news that exacerbates these trends, such as Corona, will harm stocks. Without an indication of a longer term decline in the US economy and a more pessimistic consumer, we view these corrections as short duration events and opportunities to buy for a V bottom.