S&P 500 might not be a good choice?
The stock market's monthlong rally had gone too far. More gains for the near-term won't come easily.
The S&P 500 had gained as much as 17% since its early October low point of its bear market. Driving the rally is a declining rate of inflation, would could mean that the Federal Reserve's interest-rate hikes are having the desired effect. If the central bank ended rate hikes, that could mean a bottom in economic growth.
There are a few issues with the resulting rally, however.
The first is that economic growth -- and corporate earnings -- will continue to get hit before any recovery takes place. Just last week, $Apple(AAPL)$
Disappointing earnings combined with higher stock prices have driven stock valuations higher. The S&P 500's aggregate forward price/earnings multiple is now at about 18.4 times, up from 15.3 at the index's October low. For every dollar of earnings of the index, an investor pays about $18.40 to own the S&P 500.
The index yields 5.4%, only 1.8 percentage points better than the yield on the safe 10-year U.S. government bond. That's not a lot of extra compensation for taking on the risk of buying stocks, and it's below the typical premium. Historically, the S&P 500 tends to yield about three or four percentage points more than the 10-year bond on average, according to Morgan Stanley. In short, the rally has made stocks too expensive.
"There's an element of that "FOMO,'" or fear of missing out, said Dave Donabedian, chief investment officer of CIBC Private Wealth, U.S.
The other problem is that the Fed may not even be finished with its rate hikes. Friday's hotter-than-expected January jobs report signifies that inflation may decline rather slowly, forcing the Fed into more rate hikes from here. That means more pressure on economic demand -- and on companies' profits.
The jobs report has already been the catalyst moving stocks downward in the past couple days. The S&P 500 is experiencing its second straight day of declines Monday.
That the market is experiencing weakness at this level isn't a surprise. The S&P 500 is just above 4100, a level where sellers have emerged to slow down the index's rise several times in the past few months. The market needs to see either lower rates or higher earnings expectations before buyers come in at this level.
That makes reaching the 4200 mark an even harder one to achieve. That's also a level that has lured sellers to come in and knock the index down, too. Last week, the index rallied to just under that level before promptly dropping. The index also failed to surpass that level after a late August rally and an early June gain.
"We expect 4200 to act as formidable resistance and see the SPX turning lower from here," wrote Jonathan Krinsky, chief market technician at BTIG.
The market will get there, but it's probably going to take some time -- and have many fits and starts.
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