Although the official end of spring doesn’t happen until June 19, with school out across the nation and Memorial Day in the rearview mirror, summer is effectively here. Baseball, cookouts and vacations are in full swing, as they always are this time of year.
There is one oddity about the summertime so far, however — the stock market is forging ahead. The S&P 500 is up 4% from its May low, and hit new multiweek highs on Monday of this week. All current indications are that the bulls have every intention of keeping the rally alive.
And yet, investors planning on enjoying some rare upside this summer may want to temper their expectations despite the present appearance of strength. There just aren’t enough reasons to not expect the usual summer lull from the stock market this year.
3 Problems the S&P 500 is Facing
The momentum is undeniably bullish. As was noted, the S&P 500 has gained 4% in less than a month, and is up nearly 16% from its February lows. The deck may be quietly stacked against stocks right now, however, for three distinct reasons.
1. The Trailing Price-To-Earnings Ratio for the S&P 500 Is Already Too High
Based on Standard & Poor’s numbers, the S&P 500 has earned a total of $98.70 over the course of the past four reported quarters. That translates into a trailing P/E of 21.3. Based on the projected earnings of $121.63 for the coming four quarters, the forward-looking P/E ratio — an improvement that largely relies on a continued rebound in oil prices — stands at 17.3.
Even removing the implosion of crude oil prices, the S&P 500’s income for the past four quarters would have been in the order of $112.34, leading to a trailing P/E on the order of 18.8. For perspective, the market’s long-term average trailing P/E is 16.7. The average forward-looking P/E has been 16.5 for the past 25 years.
It’s possible for the stock market to work its way to even higher valuations. It’s rare, however, for stocks to remain that far removed from their average valuations.
2. Summer Tends to Be Slow for Stocks Anyway
Though July tends to be a decent month, with the S&P gaining an average of 0.85%, June and August are quite subpar. The average June performance is -0.10%, and the average August move is -0.27%. Exceptions exist, but the averages are the averages for a reason.
That being said, 2016’s performance-to-date is already measurably more bullish than the norm to-date, suggesting the odds particularly favor a summertime pullback this time around unless this year is going to be an exception to the norm.
This isn’t really a “miraculous exception” kind of economic environment, however.
3. With or Without Valuation and Calendar Problems, Technical Resistance Is Dead Ahead
More often than not, prior highs and lows for the stock market don’t end up meaning much in the way of resistance and support. In this particular case though, the potential resistance has been well established and is already causing problems.
The first of those proven ceiling for the S&P 500 is the 2,110 area, where the index topped out in April as well as November. That was also an on-again/off-again ceiling all during the choppy period in the middle of last year.
Even beyond the 2,110 area though, another ceiling has been established at 2,135, where the market struggled for several weeks in the summer of last year.
Bottom Line for the Stock Market This Summer
No investor can afford to ever say never. On the flipside, no investor can ever afford to blindly assume the stock market will easily defy the odds either.
And right now, the market has got not one, not two, but three headwinds to face.
None of this is to suggest we’re at the precipice of a new bear market, or even on the verge of a major correction (although a healthy correction would do us some good). It is to say, however, that the current risk-vs-reward scenario is more than a little light on the reward side of the equation, and a bit heavy on the risk side … even if the rhetoric is still ringing optimistic.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
