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Are US stocks overvalued?

The US Stock Market Is Overvalued

From the perspective of economic fundamentals US stock market is overvalued. Looking back through more than a century of financial data, the long-term average P/E ratio for the S&P 500 has been about 15. Currently, the P/E ratio for the S&P 500 stock index reached 29. That’s high– more than 78% higher than the long-term average. When P/E multiples are at extremes below historical averages it makes sense to buy the S&P 500 (P/Es are above 29 currently and this is high). Analysts expect returns to be strongly positive when P/E multiples are at extreme lows and to be negative when P/E multiples are at extreme highs.

Also indicator of the stock market, known as the “Buffett Valuation”, shows that stock market is overvalued. The Buffett Valuation looks at the total value of the stock market relative to the country’s GDP and according to this indicator stock market is about 20% larger than the entire US economy (the total size of the US stock market according to Federal Reserve data is $22.6 trillion, meanwhile the total size of the US economy is $18.8 trillion).

According to some analysts stocks aren't badly overvalued. Rather, they seem reasonably close to fair value. Yields on Treasury bonds, the safest asset class of all, do not compensate investors for the inherent risk of those instruments. The 10-year Treasury yields about 2.4 percent. For an investor with a tax rate of 33.3 percent, the after-tax return of 1.6 percent is well below the rate of inflation of the core and total consumer price indexes, and about equal to the Fed’s preferred personal consumption deflator of 1.7 percent, yet below the Fed’s 2 percent policy objective.The willingness of some investors to own Treasuries instead of corporate bonds or stocks can only reflect the ongoing fear of these investors to invest anywhere else other than the absolutely safest investment that exists. In this context, stocks are fairly valued and bonds are quite expensive. As for the future, many factors may emerge that can increase or decrease the attractiveness of stocks, albeit with more potential positives than negatives ( according to this analysts).

In my opinion this is not time for investing in the US stock market, risk/reword ratio is not good, markets have made a very big jump with out correction, geopolitical concerns have influence on the markets. My opinion is that investors are starting to behave a little nervous - First, from the perspective of economic fundamentals. The second reason has more to do with the effect of noise, in this case, arising from geopolitical concerns (the increase of tensions between the U.S. and Syria, increasing tensions with North Korea, and also the deployment of the U.S.'s largest aerial-delivered ordnance in Afghanistan). The US stock market is general overvalued although you can still find good and undervalued stocks. A sizable setback could occur at any time, and I would recommend to the potential investors to be cautious and to have "stop loss" orders because markets could react with strong fall on bad news. In my opinion all good news are already priced in.

 

 

Fed, US economy, Geopolitical risks

Analysts continue to expect economy will expand at moderate pace over next few years in the US. The US economy added 98,000 new jobs in March, marking the smallest gain in almost a year. According to some analysts this is a disappointing jobs report coming in well below consensus (This is not my opinion, the unemployment rate fell to 4.5% from 4.7%—the lowest level in almost 10 years). The Federal Reserve has begun to move its policy interest rate target faster. Fed officials moved the target federal funds range in the middle of December 2016 and then made another move in the middle of March 2017. After the March meeting, the target range was 0.75 percent to 1.00 percent. The US Central Bank hiked rates as largely anticipated, but retain the stance of a slow pace for upcoming hikes, being far more conservative than expected. Less hawkish Fed monetary policy outlook continues to weigh on the US Dollar and further collaborated to the pair's downward trajectory.

The "forward guidance" provided by Fed officials is for two more moves to take place this year. The projections for the federal funds rate released by the Federal Open Market Committee is as follows: the average rate projected for 2017 is 1.4 percent; for 2018 is 2.1 percent, and for 2019 it is 3.0 percent.

The US Dollar came under some renewed selling pressure after a weak CPI report and softer retail sales data last week (this could have an impact on FED). Inflation fell more than expected and came-in to show a decline of 0.3% during March. Meanwhile, the core CPI also unexpectedly eased to 2.0% y-o-y, clearly suggesting that the inflationary pressure in the US economy has started easing. US Dollar has also weakened after Trump's comments. U.S. President Donald Trump said that U.S. dollar is getting "too strong". He also likes a low-interest rate policy, while adding that a strong US Dollar "will hurt ultimately the U.S". Geopolitical risks are in the center for traders (terrorist attacks in Russia and Sweden and the U.S.' airstrikes in Syria, the U.S. deployed the GBU-43B, a 21,000-pound bomb on an ISIS tunnel complex in eastern Afghanistan on Thursday, conflict with North Korea..). Analysts think those negatives led investors to bet that the Fed would delay the timing of its next expected rate hikes into the third quarter of 2017. According to some analysts, U.S. Federal Reserve will be more likely to pursue a policy of greater stability with respect to U.S. interest rates, which would be realized by the Fed keeping interest rates steady for a longer period of time.

 

Technical analysis

Dow Jones Industrial Average - for now there is no sign of trend reversal

The Dow Jones Industrial Average (DJIA) breached 20,000 for the first time on January 25.The DJIA bounced off the 20,604 level after the US President Trump stated that he will greatly reduce taxes.

A report on inflation, consumer prices, fell for the first time in 13 months. The consumer-price index for March dropped to a seasonally adjusted 0.3% on cheaper fuel costs, compared with forecasts for 0.1%. Inflation fell more than expected and came-in to show a decline of 0.3% during March. Meanwhile, the core CPI also unexpectedly eased to 2.0% y-o-y, clearly suggesting that the inflationary pressure in the US economy has started easing.

Geopolitical risks are in the center for traders (terrorist attacks in Russia and Sweden and the U.S.' airstrikes in Syria, the U.S. deployed the GBU-43B, a 21,000-pound bomb on an ISIS tunnel complex in eastern Afghanistan on Thursday, conflict with North Korea..).

When we look at 5 year chart we see that Dow Jones Industrial Average is moving in "uptrend". As long DJIA is above this trend line and 20,000 points this index is in the "BUY" zone ( 20,000 and 19,000 represent support levels). Short term support and resistance levels are 20,400 and 21,000/21,500 points - If DJIA jumps above 21,500 points that would be a confirmation of "BULLISH" trend. If DJIA falls below 19,000 points it would be strong "SELL" signal and than we have open way to 18,000 level support. Stocks remain expensive, but index inflows keep supporting the market, and for now there is no sign of a major dip emerging any time soon.

 

S&P 500  - for now there is no sign of trend reversal

According to fundamental metrics the market is currently overvalued. When P/E multiples are at extremes below historical averages it makes sense to buy the S&P 500 (P/Es are above 29 currently and this is high). Analysts expect returns to be strongly positive when P/E multiples are at extreme lows and to be negative when P/E multiples are at extreme highs. Positive thing is that financials start earnings season on a positive note (Technology earnings as a sector are likely fine and quite healthy).

When we look at this chart we can see that S&P 500 Index is moving in "uptrend". As long the S&P is above this trend line and 2,250 points this index is in the "BUY" zone ( 2,250 represent support level). If S&P jumps above 2,400 points that would be a confirmation of "BULLISH" trend and open way to 2,500 resistance.  As long is the S&P is above 2,250 points short term trend is "bullish" ( this index is in the BUY zone) and there is no indication of trend reversal. If the S&P falls below this trend line it would be strong "SELL" signal and than we have open way to 2,000 level support.

 

Trends like these will show signs of weakness first before they reverse, for now there is no signs of weakness. The average Wall Street strategist currently sees the S&P 500 ending 2017 at a level of 2,414. That's an additional gain of 4% from the S&P's current level.

 

 

NASDAQ 100 Index  - for now there is no sign of trend reversal

When we look at this chart we can see that NDX Index is moving in "uptrend". As long the NDX is above this trend line this index is in the "BUY" zone and there is no sign of trend reversal. If NDX jumps above 5,400 points that would be a confirmation of "BULLISH" trend and open way to 5,500 resistance.  As long is the NDX is above 5,300 points short term trend is "bullish" ( this index is in the BUY zone) and there is no indication of trend reversal. If the NDX falls below this trend line it would be strong "SELL" signal and than we have open way to 5,000 level support.

To be perfectly clear, nobody knows where the Dow Jones Industrial Average, S&P 500 and NDX will be at the end of 2017 (or in next one, two or six months)

  • The forecast for (analysts expectations) - Dow Jones Industrial Average - Q2 2017 (20500 points), Q3/17 (20200 points), Q4/17 (20300 points)
  • The forecast for (analysts expectations) - S&P 500 - Q2 2017 (2300 points), Q3/17 (2200 points), Q4/17 (2400 points)

 

Earnings

Positive thing is that earnings season start on a positive note. Energy will be the biggest contributor to overall earnings growth in the quarter if the sector can match or exceed estimates. But financials and technology, the sectors with the two biggest weights in the S&P 500, are expected to do more than their fair share by potentially producing mid-teens earnings growth year over year. Financials are likely to benefit from the rise in interest rates over the past year, along with healthy capital markets and credit conditions; help from deregulation is probably coming later in the year (something we will surely hear about this week as several big banks report). Technology earnings should get support from strength in semiconductors and software. According to analysts the S&P 500 appears likely to produce double-digit year-over-year earnings growth for the first quarter, powered by energy’s rebound. The estimates for the first quarter are calling for a solid 10.1% year-over-year increase in S&P 500 earnings. With potential for the roughly 3% upside companies typically generate, that makes growth in the 12–14% a reasonable expectation.

Analysts continue to expect corporate tax reform to get done around the end of the year or early 2018 and to potentially boost earnings by somewhere in the 3–7% range once implemented. A reduction of the corporate tax rate to 25% remains doable, in analysts view, and would likely be paid for partly by repatriation (a lower tax rate to bring overseas earnings back to the U.S.), which enjoys bipartisan support and support from corporate America.

 

Conclusion

  • From the perspective of economic fundamentals US stock market is overvalued
  • Looking at the technicals, we can see that the S&P 500, Dow Jones and NASDAQ are bullish on every single time frame
  • Markets will react more stronger on the negative news than on positive in the next 2-3 months, a number of analysts and strategists over the past few days are cautioning that worrisome trends are starting to crop up as equities take the escalator higher, pointing to a market that is getting overheated
  • In my opinion this is not time for investing in the US stock market, risk/reword ratio is not good, markets have made a very big jump with out correction, geopolitical concerns have influence on the markets
  • I would recommend only for short term traders who are trading with "stop loss" and "take profit" orders
  • Geopolitical risks are in the center for traders (terrorist attacks in Russia and Sweden and the U.S.' airstrikes in Syria, the U.S. deployed the GBU-43B, a 21,000-pound bomb on an ISIS tunnel complex in eastern Afghanistan on Thursday, conflict with North Korea..).
  • The US stock market is general overvalued although you can still find good and undervalued stocks. Analysts continue to expect economy will expand at moderate pace over next few years in the US ( US economy is healty)
  • Positive thing is that earnings season start on a positive note. Energy will be the biggest contributor to overall earnings growth in the quarter if the sector can match or exceed estimates. According to analysts the S&P 500 appears likely to produce double-digit year-over-year earnings growth for the first quarter, powered by energy’s rebound. The estimates for the first quarter are calling for a solid 10.1% year-over-year increase in S&P 500 earnings
  • To be perfectly clear, nobody knows where the Dow Jones Industrial Average, S&P 500 and NDX will be at the end of 2017 (or in next one, two or six months) - we can see 2-3% rise in next 30 days (in my opinion all good news are already priced in) and 4-6% pullback in next 2-3 months to back-test the breakout levels
  • Bottom line - From the perspective of economic fundamentals US stock market is overvalued but as long DJIA, SPX and NDX are above 20,000, 2,250 and 5,250 there is no fear of the "bear" market

 

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