Confession time: If you told me a year ago we’d be having the “S&P 2000” discussion in June 2014, I would have said you were crazy. And yet, there it is — the S&P 500 closed at 1950.79 on Tuesday, getting within 49 points of the key level.
Wow.
There’s a flipside to all the euphoria associated with the S&P 500 reaching a major line in the sand, of course — there’s a good chance the so-called “smart money” is already thinking this is the right spot for the market to finally give us that long-overdue technical correction. And if they’re thinking it, they might already be planning it, possibly creating a self-fulfilling prophecy.
Adding to the bearish argument is another stark reality: The market’s fundamentals are also arguably saying a correction is in order.
So, as we have our little chat about S&P 2000 … just know that things could get weird.
Too Good to Be True?
From a momentum perspective, things couldn’t look healthier. The S&P 500 is up nearly 19% for the past year, and is up more than 4% in just the past three weeks. Perhaps more important, the S&P 500 finally worked its way past a technical ceiling around 1900 and never looked back.
To be fair, plenty of pundits have also been calling for higher highs once stocks got back on their proverbial horse in late-May. S&P Capital IQ upped its 12-month target on the S&P 500 to 2100 last week, shortly after it surpassed the previous target of 1985. And Oppenheimer’s Ari Wald was recently semi-quoted as saying we’re about to enter the greatest bull market we’ve seen in 85 years.
The headline was a little misleading. Wald actually was describing the fact that if the rally can last for two months, it will have become the longest-lasting, uninterrupted bull run (of 64 months) we’ve seen in 85 years. And Wald still believes this bull market has many more years of life ahead of it.
But there’s just something uncomfortable about how decidedly bullish the rhetoric has become in just the past few weeks.
Don’t Plan That S&P 2000 Buying Party Just Yet
I know it’s going to be an unpopular idea, raining on the parade a bunch of investors have only joined this month. But, odds are good the S&P 500 is close to a top … if it’s not already there.
This isn’t entirely a gut feeling, either. There are three potential stumbling blocks dead ahead.
- The trailing valuation for the S&P 500: As of Tuesday, the index is valued at a trailing 12-month P/E of 18.5. We’ve seen higher, but it’s been rare that stocks have thrived with that kind of valuation backdrop. Granted, the forward-looking P/E of 16.5 is a little more palatable. That projection implies earnings growth of more than 14% over the course of the coming 12 months, though. That’s a tall order, particularly when the eurozone is in need of stimulus, retail spending in the U.S. for April was notably weak, and the Fed reporting waning industrial productivity for April. It all suggests Q2’s GDP figure isn’t going to be significantly better than Q1’s tepid growth.
- Rational or not, investors see big, round numbers as logical ceilings and floors for indices … and trade them accordingly: Oh sure, they only consider those big, round numbers as highly catalytic when there’s other context in play (like now), but the fact that the S&P 2000 discussion is happening at all here says they’re thinking about it. Ergo, the odds of the aforementioned self-fulfilling prophecy are cranked up.
- Last but not least, while it’s yet to be a problem, there’s a stark lack of volume thus far in this rally: If the majority of investors really believed stocks had an immediate bullish future, they should have started piling in by now. The chart of the S&P 500 below also includes a plot of the NYSE’s daily volume. It has been below average since early May.
We can’t just chalk it up to seasonality, either. The average NYSE volume for the past 50 days is a paltry 1.93 billion shares, but at this same point in 2013 it was a healthier 2.34 billion shares. In mid-June of 2012, the NYSE was seeing average daily volume of 2.71 billion shares. There’s a serious lack of participation in this rally. There has to be a reason.
Bottom Line
Yes, you can interpret everything you just read as my call for a pullback.
Before pulling out your pitchfork, though, I’m not saying we’re at the beginning of a new bear market.
All I’m saying is that the S&P 500 has rallied for 32 consecutive months without doling out a pullback of 10% or more. That’s twice as long as the average 18-month run-up between such sized corrections, according to Standard & Poor’s Sam Stovall.
The law of averages eventually will kick in, and with the S&P 500 as technically overbought as it has been in months here in the midst of S&P 2000 mania, the risk of it kicking in now doesn’t justify whatever additional upside might be in the cards.
And just for the record, the S&P 500 might actually need to push a tad past 2000 to get the bearish ball rolling. That fakeout would create the most frustration for investors, luring the last of any would-be new buyers into stocks right before the other shoe drops.
However it’s going to pan out, now’s not the time to be adding new long trades.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
