Like many of you when we look at the current euphoria in the equity markets, we can’t help get an uncomfortable feeling that we have been here before and it did not end well. US equities have benefited from Fed liquidity, increased leverage, and low volatility. By year-end the Fed’s balance sheet will hit $ 4 trillion and we expect renewed talk of the cost/benefit of quantitative easing (QE).
The S&P 500 could likely hit 1825 by year-end and the risks of a major top are rising. The question then becomes, “Do we as investors continue to ride this wave of momentum or is it time to take some profits?”
Our view is that given the extreme optimism readings in sentiment and aggressive earnings expectations, that the market is becoming more vulnerable to a correction. However, any pullback should be viewed in the context of an ongoing uptrend. The S&P 500, with a consensus forward Price-to-Earnings ratio of 14.5, has some room to grow before it reaches its historical average of 15.5 times earnings. When taking into account inflation and long term interest rates, it’s hard to claim that equities are significantly overvalued. We still view US stocks as the best house in a bad neighborhood.
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