New York, Nov 2019: Specialist Anthony Rinaldi, left, and trader Ashley Lara work on the floor of the New York Stock Exchange. Image: Richard Drew/AP/Shutterstock

The S&P 500 large stock index, and the C Fund that tracks it, increased to new all-time highs last week. The index is now up for the past five weeks in a row.

Chart Source: CNBC

Along with this rally, CNN’s fear and greed index recently went over 90 for the first time since 2017:

Chart Source: CNN

The fear and greed index is based on put/call option ratios, various momentum indicators, bond demand, and volatility levels.

In addition, the American Association of Individual Investors (AAII) sentiment survey recently hit its highest level of bullishness since May of this year. A larger than average percentage of respondents indicated that they are bullish.

These sorts of surveys or indicators are often considered contrarian indicators, meaning that one should be careful of following them. Both of them tend to show fear and bearishness during big sell-offs when stocks are cheaper, like December 2018 when it was a great time to buy, and tend to show greed and bullishness during expensive market peaks.

Corporate Earnings Season Nearly Over

S&P 500 earnings for Q3 came in better than some feared, with 75% of companies beating estimates so far. However, the estimates were very low to start with. With 90% of the S&P 500 having reported third quarter results as of this writing, the average year-over-year revenue growth was 3.7% and the average EPS growth was -1%. This was inclusive of buybacks propping up EPS, so company-wide net income dropped a bit further than just -1%.

With stock earnings down and stock prices up, the cyclically-adjusted price-to-earnings (CAPE) ratio of the S&P 500 is back over 30, indicating rather high market valuations:

Data Source: Prof. Robert Shiller

Federal Reserve Balance Sheet Expansion

In recent articles, I’ve been covering a major shift in U.S. monetary policy by the Federal Reserve. This is one of the potential catalysts for the market to be doing so well at the moment.

After a long and gradual reduction, the Federal Reserve has now expanded its balance sheet by over $270 billion in the past eight weeks. During these activities, they are creating money to purchase treasury bills from large banks, which significantly increases liquidity in the financial system. The following graph shows the remarkable U-turn that has occurred since mid-September when the Fed began intervening in the overnight lending market to fix the liquidity problem that had occurred there.

Chart Source: St. Louis Fed

Since September, the Federal Reserve has performed overnight lending operations, 2-week lending operations, and began outright buying treasury bills at a magnitude of $60 billion per month.

We are at an economic inflection point at the current time. Some economic indicators have shown signs of stabilization after over a year of deceleration, but current forecasts by the Atlanta Fed and New York Fed see slower GDP growth during this fourth quarter of the year. As more data come in, we’ll hopefully get more clarity regarding whether the U.S. economy continues to slow, or if the period of slowing may be getting ready to turn around to the upside.

Asset Allocation

Investors should be careful not to chase recent performance based on quick emotional decisions. Asset allocation should usually be based on your long-term goals and your risk tolerance. Decisions to increase or decrease your allocation to equities, for example, should be well thought-out and applied for good reasons. For many investors, the Lifecycle funds can be ideal investment vehicles because they are consistently diversified and rebalance themselves over time.

More on the Lifecycle funds here: The Pros and Cons of Lifecycle Funds

Lyn Alden is a financial writer and an engineer, and holds a bachelor’s in engineering and a master’s in engineering management, with a focus on financial modeling and resource management. She specializes in analyzing and presenting financial data. Her investment work can be found on LynAlden.com.