The S&P 500 ended the week at yet another all-time record high.
Some have tried to compare the current peak to the stock market tops we’ve seen in 2000 and 2007.
However, many — like Reformed Broker Josh Brown — are quick to remind everyone that the comparisons stop with nominal price. Relative to earnings, stocks are clearly much more reasonably priced than they were before the last two market crashes.
This is not to say that there aren’t things we should worry about.
“I am troubled to see that forward earnings has been stuck around its record high of $115 for the past nine weeks,” wrote market guru Ed Yardeni earlier this week. “This is the measure of earnings that I believe drives the market.”
Indeed, this earnings growth stagnation amid rising stock prices have caused valuations to become less attractive.
In a piece for Itaú BBA titled “Developing Euphoria,” hedge fund manager Felix Zulauf raises similar concerns. Interestingly, he draws comparisons between the stock market and the gold market. Here’s an excerpt (emphasis added):
The problem with currently rising equity markets is not rising prices but the lack of fundamental improvement. Stock prices are driven primarily by this lack of alternative investment opportunities and the growing belief that central banks’ money printing can and will generate attractive investment returns for equity investors for a long time despite the lack of supporting fundamentals in the real economy. That is a risky assumption, but as long as rising trends remain intact, nobody worries. In fact, the momentum of the leading equity market indices (Japan, the U.S., Germany and Switzerland to name some) is very powerful and has the potential to carry further, potentially even into a buying climax. Similarities to the gold price in spring 2011 come to mind. At that time, the conviction that gold could only go one way because inflation will eventually rise was as extreme as is now the case for equities.
Once equity markets discover the emperor has no clothes, they could face a quick and painful adjustment to bring markets in line again with fundamentals. For the gold market it was when investors realised there was no rise in CPI inflation or the assumption that systemic risks are declining. It is true that equities look attractive relative to fixed-income alternatives from a valuation point of view, when depressed fixed-income yields are compared to dividend yields or earnings yields (reciprocal of P/E ratios). Those comparisons are all fine as long as economies do not fall back into a recession and earnings stay at least stable. As investors are not expecting a recession, they still believe equities are by far the best place to be, and they act accordingly. That’s why we might see an end to this cycle with a bang (buying climax) and not a whimper (conventional broadening cycle top).
Simply put, gold exploded higher amid fears of liquidity-driven rampant inflation. In a similar sense, stocks are currently in rally mode on expectations that an improving economy will eventually translate into earnings growth.
In his piece, Zulauf also offers his take on austerity, debt, bonds, gold, and Japan. He also provides a lengthy perspective on currencies.