As Sam Sees It: Why the Bull Market Hasn’t Topped Just Yet

Sam Stovall  |

Each week, we tap the insight of Sam Stovall, Chief Equity Strategist for S&P Capital IQ, for his perspective on the current market.

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EQ: Second quarter reporting season is in full swing. With the market currently in line with long-term values, are we getting the type of earnings growth we need to justify projected gains in the market?

Stovall: Yes, I think we are because while the S&P 500 is up almost 8% in the second quarter, we’re now seeing earnings increases that are approaching 7.5%. We’re likely to see EPS growth for the full year that’s closer to 8%.

Since we had a very sharp P/E multiple expansion last year, I think to catch up with the earnings growth that we’re seeing since the bottom of the prior bear market, 2014 is becoming a “show me” year in which prices will probably rise by an amount similar to what earnings increases eventually show.

EQ: Even if fundamentals are suggested that the market is at fair value right now, that isn’t to say that the market couldn’t be trading in overvalued territory for a significant period of time, does it?

Stovall: That’s right. Right now, when you look to historic and projected P/E ratios, they’re slightly above fair value. Even if you overlay inflation onto it, we’re still looking at P/E ratios that are not off-putting, even if they’re certainly not compelling. So I would say that the market still needs to move higher and P/E multiples need to expand further before one can really say that the market is trading at levels of excess.

EQ: In this week’s Sector Watch, you examined the likelihood that our overdue pullback or correction could potentially slip into a deeper bear market. What were the indicators on this “Bear Basics” checkup?

Stovall: There were several indicators that I looked at. There were economic indicators like GDP; leading economic indicators like unemployment and housing starts; monetary indicators like the yield curve; valuation indicators like P/E ratios, in particular; a sentiment indicator from the American Association of Individual Investors, and price action in terms of how far the S&P 500 was away from its 50-day and 200-day moving averages.

Quite frankly, for whatever indicators that seemed like they might appear a little bit rich, you could find another indicator that was more than offsetting. In particular, while the P/E ratio currently is higher than eight of the prior 11 bull market tops, the yield curve (difference between 10-year treasury yield and one-year treasury yield) is at 2.4%, and is basically twice that and higher than any of the top levels we saw going back to 1948.

So the yield curve looks very attractive for stocks, and offsets the concern of valuations. Also, sentiment right now based on the AAII survey is about half of what it normally has been at market tops. Again, this look at what I call the Bear Basics data indicates that while we could get a pullback or correction at any time, I don’t think we are ripe for a new bear market.

EQ: Interestingly, the last time you did the Bear Basics check in February 2013, the market has gained 30% since.

Stovall: Right, and still we are not in overvalued territory after that 30% gain. We have seen earnings increase as interest rates have actually declined over the past seven months. So even though things look good, there is additional reason in my opinion to believe the market could continue to work its way higher.

EQ: Of the various economic indicators, is P/E ratio the closest one approaching a level of concern?

Stovall: Yes, it is. However, I would also be quick to say that P/E ratios are probably not your best market-timing indicator. On several occasions the S&P 500 topped out while the P/E ratio was in single digits. You also have to look at inflation, or in a sense, the Rule of 20, which looks at P/E plus inflation.

Right now, with us being at 21.2 for the S&P 500, that’s still below the average of 22.2 for all bull markets going back to 1948. We’re also currently below many other occurrences, such as in 2000 when the Rule of 20 was more than 33, or in 1987 when we were close to 25, and in 1961 when we were above 23.

So again, the market could end up becoming more overvalued before it ends up toppling over from being too top heavy.

EQ: Last week, we discussed the fear of missing out, and knowing that a bear market is most likely not around the corner, should investors be looking at these impending pullbacks and possible correction as an opportunity to get back into the market?

Stovall: Because I don’t think another bear market is right around the corner, I would tend to say that investors probably should use pullbacks and corrections as reasons to add to their holdings rather than reasons to run from their portfolios.

I think what it’s indicating is sometimes we can try to be too smart for our own good, and as a result, we end up looking for indicators in the market to justify a position that we happen to hold, only to cause us to be on the sideline while the market then passes us by. So the old saying that the trend is your friend until it ends, in this case, is very appropriate.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to:


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