It’s hard to tell when a raging party is winding down or simply taking a breath. Investors are celebrating the SP 500’s new record high, but will it keep ginning up, or is it time to bail?
Barron’s Next put on the hats of a strategist, a technical analyst, and a behavioral finance expert to get different perspectives on the recent market highs.
A market strategist studies fundamentals, such as company valuations and earnings potential, a technical analyst studies price movements and charts to identify changes in the market, and a behavioral finance expert studies the psychological factors that drive investors to act. Think of a patient being assessed by a general practitioner, a specialist, and a therapist.
The SP 500 recently hit an all-time, climbing past 2200. Graphically, it looks like a significant milestone, but relative to how much companies in the index are earning, the SP 500’s price looks relatively modest. The index now trades at roughly 17 times what SP 500 companies are expected to earn in the coming year. Back in 1999, that ratio peaked at 28. The current multiple also isn’t much higher than the index’s 20-year median of 16. The time to worry is when stock prices are moving higher, but company earnings aren’t. In this case, it appears that they are climbing together.
The Technical Analyst:
Robert Sluymer, a technical analyst at RBC Capital Markets, has been bullish on the market since February, arguing that the government’s efforts to boost the economy were taking hold. When looking at a chart of the SP 500, he sees that it peaked in mid-2015, then headed sideways for a while before moving up again in November and then falling early this year, to 1800, what he calls a “supportive level.”
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At the same time Sluymer noticed that the 4-year moving average, a long-term proxy for market movements, was rising. Think of a moving average as the water level in a swimming pool. A diver can jump in and sink below the water but eventually rises back up. In the world of stocks, the moving average creates a floor, or cushion. If it’s rising, stocks move with it. Add in good news, and stocks have the potential to hit new highs. Meanwhile, that four-year moving average is likely to support stocks near current levels. “The longer-term trend remains positive,” Sluymer says.
The Behavioral Finance Expert:
The prefrontal cortex, the human brain responsible for problem solving and processing complex thought, developed during the Stone Age. Back then, this part of the brain was used to figure out what could happen based on a small sample of information — critical to finding food and shelter. Investors practice similar analysis. When they hear “all-time high” they might think “more good things are coming,” says Meir Statman, a finance professor at Santa Clara University. That’s the kind of sentiment you hear from gold and silver advertisers on late-night TV. “‘Gold is up however much! Buy now!’—this is a play on people’s sense for continuation,” Statman says. Often this psychology helps to drive stocks higher, even if it’s not always the wise move.
The stock market, even at current highs, gets a passing grade from three schools of thought.