I’ve covered in previous articles that the S&P 500 (which the C Fund tracks) is rather expensive by many metrics.
For example, the difference between S&P 500 prices and S&P 500 fundamentals is the widest it has been in twenty years. This chart shows the S&P 500 price (black line) compared to what it would be at if it were to trade at its historically average valuation over those past twenty years (blue line):
Low interest rates and high investor sentiment can hold up equities for quite a while. For example, instead of coming down, it’s certainly possible for the index to consolidate sideways for a couple years as earnings eventually catch back up.
After this month’s correction, though, we are seeing some damaged technical charts for the S&P 500.
Here is a 3-year daily resolution chart, showing the S&P 500 close below its 50-day simple moving average for the first time in this 2020 rally:
And here is a 5-year weekly resolution chart, showing MACD (a trend indicator) potentially getting ready to roll over:
It remains to be seen whether investors will “buy the dip” and this will end up being another short-lived sell-off, or if it could continue snowballing into something larger.
On one hand, with fundamental valuations quite high, and some technical weakness, there is plenty space down below for a sizable correction. Nothing about that would be unusual.
On the other hand, the market has been rather relentless at buying dips in recent years, and bear markets have all been shallower or quicker than many bearish analysts expect.
With interest rates at historically low levels, and stated by the Federal Reserve to likely remain that way for years, many investors view the stock market as being something “for which there is no alternative”.
To add to that uncertainty, fiscal policy is a big unknown variable. So much fiscal spending was pumped into the economy earlier this year, and that helped household balance sheets, company fundamentals, and asset prices. Whether the market can continue to levitate, or if it drops into a significant correction, could in part depend on whether there is another stimulus package this calendar year or not.
For me, fiscal policy is the tiebreaker. With valuations high and technicals not looking great, I’m inclined towards a bit of defense until fiscal policy becomes more clear.
That doesn’t mean I’m avoiding stocks, but it means I’m quite diversified, and not at my personal maximum equity allocation. I have exposure to U.S. equities, foreign developed equities, emerging market equities, precious metals, real estate, Treasuries, and other assets.
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.