MARKET SNAPSHOT: The Trump Rally In The Stock Market May Be Turning Into A Bubble
04 December 2016 - 12:15AM
Dow Jones News
By Sue Chang, MarketWatch
Rotation from large caps to small caps is expected to
continue
has made the stock market great again with major indexes logging
their best performances in months in November. But that frothiness
is prompting warnings that the market is getting too bubbly,
setting up investors for a disappointment in coming weeks.
The S&P 500 index's forward price-to-earnings ratio, a key
metric to measure valuation, has jumped to 16.9 multiples at the
end of last week from 16.4 multiples on Nov. 8 while the P/E ratio
for the small-cap S&P 600 soared to 19.9 from 17.4 during the
same period, said Ed Yardeni, chief investment strategist at
Yardeni Research Inc., in a report.
"The valuation multiple for the S&P 600 is now the highest
of the current bull market," he said.
The spike in valuation is on the back of $1.2 billion in fresh
flows into equities in November, the largest four-week inflow in
two years, according to data from Bank of America Merrill
Lynch.
And small caps are a big beneficiary as investors rotate out of
large-cap growth shares into value stocks in anticipation of
Trump's presidency, which Kent Engelke, chief economic strategist
at Capitol Securities Management Inc., believes will be
"nationalist versus globalist."
See also: Goldman Sachs is the big Dow winner of the Trump rally
(http://www.marketwatch.com/story/goldman-sachs-is-the-big-dow-winner-of-the-trump-rally-2016-12-02)
"The odds are high there will be a roll back of some of the more
onerous regulations that have stifled small business and small
business creation," he said in a note. "Moreover I think monetary
velocity will accelerate, an acceleration that will increase
economic activity and interest rates, all which will benefit the
small companies at the expense of the mega caps."
Nonetheless, Yardeni cautioned that these valuation levels
cannot be sustained unless gross domestic product growth picks up
to 4% from the current 3% level
(http://www.marketwatch.com/story/gdp-rises-at-32-annual-pace-strongest-in-more-than-two-years-2016-11-29)
so companies can raise prices in line with inflation.
Jeffrey Saut, chief investment strategist at Raymond James, who
has steadfastly maintained his upbeat outlook on the market
throughout this topsy-turvy year, agrees that stocks are ripe for a
breather.
"The market is very overbought and it will either correct by
going sideways or lower," said Saut.
The S&P 500 closed out the week 1% lower while the Nasdaq
Composite Index fell 2.7%. But the Dow Jones Industrial Average
edged up 0.1%
(http://www.marketwatch.com/story/dow-set-to-drop-from-record-high-as-trump-rally-fizzles-2016-12-02)
for the week.
"We will likely take a pause and we could have a pullback in the
next couple weeks. Corrections are normal and I don't think it will
be more than 5%, given that underlying fundamentals are good," said
Karyn Cavanaugh, senior market strategist at Voya Financial.
Among the most vulnerable will be financials and industrials
sectors, which have witnessed strong gains over the past month.
Financial shares have risen 14% while industrials rose 8.5% in
November.
See also: Wall Street's Trump optimism comes with heavy dose of
uncertainty
(http://www.marketwatch.com/story/wall-streets-trump-optimism-comes-with-heavy-dose-of-uncertainty-2016-12-02)
That the correction coincides with a seasonally favorable time
for the market when stocks traditionally rally tips the balance in
favor of more upside eventually. Since their inception, the Dow
industrials have risen in December 71% of the time while the
S&P 500 has ended higher 74% of the time, according to Dow
Jones data.
It will be a relatively light week for economic indicators
although investors will closely track weekly jobless claims on
Thursday in the wake of disappointing jobs data this week. The U.S.
economy added 178,000 new jobs
(http://www.marketwatch.com/story/us-jobless-rates-hits-nine-year-low-of-46-in-november-2016-12-02)
in November, falling short of the 200,000 projected in a
MarketWatch survey.
It is likewise a lean period for corporate earnings with only a
handful of S&P 500 companies slated to release quarterly
results. As of Friday, with most companies having turned in
third-quarter reports, earnings rose 3.3% while sales grew 5% in
the quarter, FactSet data show.
On the international front, the Italian referendum on
constitutional changes may have some impact on the market. If
voters reject proposed reforms, it could lead to the collapse of
Prime Minister Matteo Renzi's government, paving the way for a more
populist party to take power.
A "no" vote in Italy, coinciding with a pause in the stock
market rally, could trigger more uncertainties, said Saut.
See also: What happens if Italy votes 'no' on Sunday
(http://www.marketwatch.com/story/what-happens-if-italy-votes-no-on-sunday-2016-12-01)
(END) Dow Jones Newswires
December 03, 2016 08:00 ET (13:00 GMT)
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