The S&P 500 index tracks 500 top publicly-traded American companies, represents about 80% of the U.S. equity market by value, and is tracked by the C Fund.
It has broken out to new all-time highs in 2020 despite the economic downtrend that has occurred, but is now overbought in terms of the daily relative strength index (RSI), which historically increases the odds of a correction or consolidation in the weeks ahead.
The stock market has a lot of uncertainties at the current time. It was largely supported by fiscal stimulus from March through July, but the next round of fiscal stimulus is currently gridlocked and the outcome for what will happen and on what timeline, is unclear at this time.
If we compare the S&P 500 stock index price level to analyst-consensus forward earnings of the S&P 500 index of companies, the picture doesn’t look great.
Analysts collectively expect a significant earnings decline through 2020, a rebound roughly to 2019 levels by late 2021, and an eventual breakout well into new earnings highs by the end of 2022.
Stock prices, however, have already front-run that narrative, and broke out to new all-time highs here in mid-2020, which is quite unlike how stocks usually perform in recessions. This has resulted in one of the largest-ever gaps between stock prices and stock fundamentals (like earnings, revenue, dividends, and other actual corporate performance).
Historically, these big divergences don’t usually end very well. The stock market could eventually correct downward, or could simply consolidate in a choppy sideways pattern for a while until fundamentals eventually catch back up.
It’s also of course possible that analysts are wrong, and that earnings will surprise to the upside in 2021. Even then, at current price levels, the market is a bit stretched by most metrics and due for some consolidation. These things have a habit of going higher and longer than most people expect, though.
Meanwhile, things don’t look great for small businesses and consumers at the current time, and ultimately they are the engines that support the economy.
Small business revenue sharply rebounded from late March through early July, but has since rolled over:
Similarly, the University of Michigan’s consumer sentiment index rebounded a bit after the initial crash, but instead of going back up in a “V-shape” like the stock market, it has remained quite low, which makes sense given record levels of unemployment and heavy reliance on government transfer payments to make ends meet:
Overall, this may be a good time for investors to check asset allocations relative to their targets, check their personal risk tolerances, and check investment goals to make sure their portfolios are well-constructed for their own needs in this challenging investment environment.
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.