Well, it seemed unlikely after three months’ worth of consolidation from the stock market, but the S&P 500 along with its counterpart SPDR S&P 500 ETF Trust (NYSEARCA:SPY) have both technically broken out.
It technically happened on Thursday when the S&P 500 as well as the SPY ETF both closed at record highs, but Friday morning’s bullish open has largely sealed the deal.
Or has it?
While stocks may have officially entered breakout territory, few could deny that valuations have moved to extreme levels (even on a forward-looking basis) that make it difficult to tack on more gains.
Could this current surge from the S&P 500 simply be a last-ditch effort to lure most of the recently-sidelined investors back into the market, only to pull the rug out from underneath them? It wouldn’t be the first time that has happened.
The Good (& Bad) News For the S&P 500
One may have to squint to see it, but the S&P 500’s close of 2,121.1 on Thursday was record close, clearing the recently-developed ceiling at 2,118. The index didn’t actually make a new all-time high on Thursday; the April 27 intraday peak at 2125.92 still holds that honor. The closing price is the most important price of the day, however, so Thursday’s record-breaker above 2,118 is a big deal.
The same premise applies to the SPY ETF. That is, the SPDR S&P 500 ETF Trust cleared a key hurdle at $212.07 on Thursday with its close of $212.21.
In both cases, the instrument in question has been working on its respective breakout since February, pushing up and off a rising support line to repeatedly test a major resistance line until that resistance line finally crumbled and broke. It’s a relatively good-looking ascending triangle pattern, which usually kicks off a rally.
If there was ever a time to not trust a fairly clear technical clue, however, this may well be it.
First — and this is only a minor, non-technical consideration in the grand scheme of things — the stock market loves to aggravate as many people as possible as much of the time as possible. One of the best ways of doing so at this time would be to make it appear a breakout is starting to unfurl, only to dish out the long-overdue correction just as the masses were starting to pour back into stocks again.
Only time will tell if that’s what’s happening here, but it’s a distinct possibility for which wise investors will remain prepared.
The 800-lb. gorilla in the room, however, is the stock market’s frothy valuation. As of the latest Q1 earnings season numbers, the S&P 500 is valued at a trailing P/E of 19 and a forward-looking P/E of 17.5.
Investors can’t simply blame the trainwrecked energy sector for the frothy foward valuation, either. Taking the energy sector out of the equation, the average (non-weighted) P/E for the remaining nine sectors is still 16.7 on a forward-looking basis — well beyond even the upper edge of what would be considered a normal range.
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In other words, whether they want to admit it or not, the budding rally’s participants are saying valuations don’t matter. Either that, or they’re saying the pros are underestimating earnings growth potential for the remainder of this year and all of next year. Possibly both.
It’s not that the professionals can’t be wrong. But this kind of amateur-investor hubris blindsided investors in the late-’90s and then again in 2008. Fortunately, the current swell hasn’t reached those proportions (yet).
Oh, and one more reason to worry: Although summer — the next six months for that matter — are generally regarded as a slow, tepid time of year, a closer look at all the May-through-October numbers for the S&P 500 revealed this so-called weakest six months of the year were anything but tepid.
More often than not, they were surprisingly hot or surprisingly cold. Given how vulnerable the stock market is now in terms of valuation and its overbought condition, the calendar says now would be the ideal time for the bears to growl.
Bottom Line for the Stock Market
It’s certain to be an unpopular premise here in the shadow of what’s undeniable a technical breakout from the S&P 500 and the SPY ETF, but when looking at the odds through an unbiased lens, Thursday’s and Friday’s action looks more like a fakeout than a breakout: a setup from which the stock market is going to drop the hammer on unsuspecting investors.
Bear in mind it may not happen immediately; the sheer excitement surrounding the breakout move could provide bullish traction for a few days. The smart money, however, is likely to view that last gasp of bullishness as an exit opportunity from what’s been a tumultuously bullish phase, which in turn is apt to start a chain reaction of selling.
And if the rising support lines that have been in place since February end up failing as a floor after any pullback, that’s when you should really be worried.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
