3 Reasons Why the S&P 500 Is About to Correct

If it seems like we just had the S&P 2000 discussion, you’re not crazy — we did. It was back on June 11, shortly after the S&P 500 put the pedal to the metal and put the 2000 level in its sights.

The S&P 500 closed at 1940 that day, and though it didn’t do so in a straight line, it did continue to march higher, reaching a high of 1991 on Thursday of this week.

Of course, the big question being asked now is the same big question being asked then: Will the S&P 500 push past the 2000 level and keep on chugging? Or will reaching the S&P 2000 milestone finally invite the long-overdue pullback?

Never say never, but the rally looks like it’s about to run out of gas as traders watch the S&P 500 approach a critical level.

What’s Not Right?

Just to call a spade a spade, it’s not momentum the market is lacking. The S&P 500 is advancing at the same pace now that it has been gaining at since late 2012, repeatedly leading the index to new highs (and then record highs) for months. The index has gained 47% since November 2012, and there has been no stumble greater than 6% during that time.

As they say, however, nothing lasts forever.

If there was ever an opportunity for the bears to take the reins for a while, the S&P 2000 level is it, for three reasons — the weakest of which is (ironically) effectively hitting the 2000 mark.

1. The S&P 500 has all but bumped into a big, round number. While this shouldn’t be an important factor, the reality is that because many traders believe that index values ending in two or more zeros are inherently floors or ceilings, for psychological reasons they become major floors and ceilings.

2. The index is painfully overbought. Never even mind the technical clues telling us the S&P 500 is overbought. Just from a sheer commonsense perspective, we can tell the S&P 500 has likely gone beyond realistic limits.

To give full credit where it’s due, it was data from BTIG’s Dan Greenhaus — featured in MarketWatch’s The Tell — that supplied the context. While Greenhaus’ message was that the now-70-day-old rally was nothing to worry about, the very data he was using to make his point is the reason investors might want to worry. He simply pointed out how the current advance from the S&P 500 had carried it 9.5% higher over the course of 70 trading days, which paled in comparison to the 11.6% run-up we saw unfurl in just 46 days between February and April. He also points out that the last time we saw a 70-day-plus rally (in early 2013), the S&P 500 actually advanced 13.6%. His point being, there’s still room for more upside.

What’s seemingly ignored, however, is that not one of the 10 rallies in question since early 2012 lasted more than 73 days.

From a time-based perspective, the S&P 500 is pushing its luck.

3. Valuations have reached ridiculous levels. This is perhaps the biggest concern for investors at this point in time. Assuming the latest data from Standard & Poor’s is on target and the index is on track to earn $29.64 per share for the second quarter, then the S&P 500 currently is valued at a trailing price-to-earnings ratio of 17.7.

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We’ve seen higher trailing P/E ratios, but in most of those instances earnings and/or the market were on the way down. The last time we saw a P/E ratio move above the 17.7 level when stocks as well as earnings were on the rise was in 2003 — when we were still recovering from the 2000-02 recession — and at the time, the P/E ratio was on the way down, not up.

The only time before that we saw rising earnings and rising stocks give us a valuation of more than 17.7 was in the latter half of the 1990s, when valuations were the last thing on any investors’ mind.

Bottom Line

Were it just one or even two of these impasses to contend with, the S&P 500 might have a fighting chance to continue its advance.

With all three burdens weighing in at the same time, though, this might be more than the market can shoulder.

Admittedly, there aren’t even every many subtle hints that the market is topping out here, let alone any decided hints of a top. It doesn’t matter. The stage is set. Now it’s just a matter of time, and timing.

Just to be clear, though, this isn’t a prediction of the beginning of a bear market. It’s just a call for a normal correction.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media, https://investorplace.com/2014/07/sp-500-correction/.

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