Santa Claus Already Came to Town – Prospects Dim for a Year End Rally

It has been a fantastic year in the stock market!  The S&P 500 is up 16% Year to date, bolstered once again this week by the Federal Reserve’s 0.25% interest rate cut.  Earnings are strong, economic data is generally good, and inflation is running below expectations. The good news keeps coming – which is what has us worried.

Market Sentiment

This week market sentiment, as measured by the Investor’s Intelligence Bull/Bear Ratio, a measure of investors who expect the stock market to go up (bulls) compared to investors who expect the stock market to decline (bears), topped 4, the highest ratio in over 2 years.  From a contrarian perspective, when there are too many bulls, it is usually an indicator that we are nearing at least a short-term market top. This is an imprecise science, so no one indicator can predict market movements with certainty, but such enthusiasm for the stock market has us … worried.

Valuation

Valuation is also frothy.  The S&P 500 Forward P/E Ratio, a measure of the price of a company’s stock compared to the company’s earnings, rose to 22.8 on October 30, among the highest valuations in the of the last 20 years. Could valuations continue to grind higher?  Yes.  Earnings are strong and earnings growth could continue to support and justify today’s stock prices. However, investors are paying a premium for every dollar of earnings.

Interest Rate Pause.

At the beginning of the week, stock markets were expecting the Federal Reserve to cut rates twice by 0.25% each time, once in October and again in December.  While the Federal Reserve cut rates by 0.25% as expected, they signaled caution about another rate cut in December.  At the beginning of the week a 0.25% interest rate cut in December was almost a given, with odds of a rate cut at 90%. Now odds have fallen to 65%.  If the Federal Reserve pauses interest rate cuts on December 10^th, the rally could stall.