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Stock rally’s breadth is a sign of strength, froth
Number of stocks hitting 52-week highs recalls pre-correction levels
SAN FRANCISCO (MarketWatch) — Stock indexes rallying to new highs have put investors on alert for a correction. Now they have something else to worry about: Too many individual stocks touching highs.
The S&P 500 Index (SNC:SPX) rose 2.1% last week to close at a record of 1,667.47 Friday, its 16th record close this year. Similarly, the Dow Jones Industrial Average (DJI:DJIA) rose 1.6% on the week to 15,354.40, its 21st record of the year. The major benchmarks, including the Nasdaq Composite (NASDAQ:COMP) , have made a nearly unchecked 16%-17% gain for the year. http://www.marketwatch.com/story/stock-rallys-breadth-is-a-sign-of-strength-froth-2013-05-19
It’s not just the indexes that are stretching for the stratosphere.
Also in the past week, more than half the stocks on the S&P 500 touched new 52-week highs, with 141 of those occurring on Friday alone, according to an analysis of FactSet data. Another 128 companies reached new 52-week highs earlier in the week.
“The number of people I’ve heard justifying the valuation has been mind boggling,” said Andrew Wilkinson, chief economic strategist at Miller Tabak & Co. “The complacency is now incredible but nobody knows what the catalyst will be for a setback.”
The CBOE Volatility Index (MDE:VIX) , or so-called “fear index” closed down nearly 5% at 12.44 Friday, its lowest close since mid-April. The index has fallen 31% year to date, and current levels seem more at home in 2004 to 2007 than any other time in the last 10 years.
Optimism, whether blind or not, is so rampant, short sellers are particularly miserable. Some of the most-heavily shorted stocks are outperforming the S&P 500.
“The bulls don’t have to try too hard because previous bearish forces are adding fuel to the fire, propelling the market higher,” Wilkinson said.
What has been missing from this rally is volume, owing to the slow grind of stocks higher, he said. Volume is about 14% lighter this May from the year ago period, according to Barclays. Similarly, second-quarter volume is nearly 9% off from last year.
Investment strategists often like to see a rally shared by a wide number of stocks. This breadth should give support to further gains, the thinking goes. But such widespread fortune has also been the precursor to pullbacks.
On Wednesday, 538 stocks on the NYSE reached 52-week highs, the largest number since Nov. 2, 2010, according to Jonathan Krinsky, chief technical market analyst at Miller Tabak,
Krinsky cautions that the last time there were that many 52-week highs on one day, the market experienced a 4.5% correction.
Similarly, surges of 600 or more NYSE-listed companies hitting 52-week highs in April 2010 preceded a 16% correction, which included the “flash crash” of that May, and a day of 600-plus NYSE stocks reaching 52-week highs on Oct. 3, 1997 — when the S&P 500 was up 33% for the year — was followed by a 13% decline over the next few weeks.
“While a high reading of new 52-week highs should hardly be considered bearish, we simply want to highlight that a ‘surge’ in the reading is not necessarily the most bullish indicator either, especially following a sustained advance,” Krinsky said in a recent note.
Stock prices near record highs. But are they overpriced?
The real question then becomes whether stocks are overvalued or not. Here, data on one popular measure—price-to-earnings ratios—has something for both the bulls and the bears.
The S&P 500’s forward 12-month P/E ratio is 14.4, according to John Butters, senior earnings analyst at FactSet. While that’s higher than the 5-year average of 12.9 and the 10-year average of 14.1, it’s less than the 15-year average of 16.5.
But even that might be misleading. Back on Oct. 9, 2007, when the S&P 500 hit a record high before the financial crisis, the forward P/E ratio was 15.2, below the 5- and 10-year averages of 15.7 and 18.6, respectively, Butters said.
Relatively low valuations are mostly the product of high profit margins, cautions Russ Koesterich, global head of investment strategy for iShares at Blackrock. While both forward and trailing price-to-earnings ratios for large-cap stocks are below long-term averages, corporate profits currently make up about 10% of U.S. GDP, compared with a long term average of 8%.
“There’s the implicit assumption that margins will remain elevated, Koesterich said. “If you think margins will revert to normal then some of those earnings are not sustainable.”
FOMC minutes on deck
This week, attention will once again fall on the Federal Reserve as minutes from the central bank’s last Federal Open Market Committee are released. While the Fed has stated it will more or less stay the course with its $85-billion-a-month in asset purchases, stocks are setting new highs even as the call for scaling those purchases back has been gaining momentum.
Miller Tabak’s Wilkinson said the market appears to have a grasp of what the Fed is trying to do with quantitative easing and that gradual improvements in employment and housing are giving the economy enough inertia to more forward on its own soon.
“When you get a child riding a bike with the training wheels on and they don’t need them, it looks a bit silly,” Wilkinson said.
Also, low inflation below the Fed’s 2% target gives the Fed a lot of latitude in which to act, said Blackrock’s Koesterich. The real question, he said, is how investors act when the Fed starts taking it’s foot off the gas.
Earnings season winds to a close
Next week will also see the last of the Dow industrials reporting earnings along with much of the rest of the S&P 500.
So far, 463 companies in the S&P 500 have reported first quarter earnings. Of those, 70% have topped Wall Street estimates for earnings, while only 43% have surpassed estimates on revenue, according to FactSet’s Butters.
More than 20 S&P 500 firms will report this week including Campbell Soup Co. (NYSE:CPB) , Best Buy Co. (NYSE:BBY) , Medtronic Inc. (NYSE:MDT) , TJX Cos. (NYSE:TJX) , Lowe’s Co. (NYSE:LOW) , Staples Inc. (NASDAQ:SPLS) , Target Corp. (NYSE:TGT) , Gap Inc. (NYSE:GPS) , and Sears Holdings Corp. (NASDAQ:SHLD) .
Home Depot Inc. (NYSE:HD) and Hewlett-Packard Co. (NYSE:HPQ) are the final two Dow components that will report for this season.