The first up-leg of the bull market has catapulted many Large Cap valuations to levels seen only in 1999, 2000, 2019, and pre-pandemic 2020. At the six-month point on September 23rd, the S&P 500 P/E on 5-Yr. Normalized EPS had already reached 26.9x—a reading that is 30% higher than at the same point of any other bull market.
We always do our own work and draw our own conclusions. Lately, though, we’ve wondered what the late “Monetary Marty” Zweig might say about the stock market’s current liquidity backdrop.
The 1999 leadership parallels we discussed in the latest Green Book remain intact—U.S. over foreign, Growth over Value, and Large over Small. Small Caps have given up most of the “beta bounce” enjoyed in the first two months off the December low, with one Small Cap measure—the Russell Microcap Index (the bottom 1000 of the Russell 2000)—undercutting last year’s relative strength low and those of 2011 and 2016.
Allow us to put forth yet another theory for this season’s plummet in NFL television ratings: Fed watching is back!
We think stock market action in the next few months will provide the Fed with an excuse to skip any rate increase in 2015. But our view is a minority one, and futures’ market odds on a September increase shot up in early August. Either way, the obsession over the timing of a Fed rate hike ignores the fact that world P/E ratios are already contracting—at least on the basis of our 5-Year Normalized EPS.
While our stock market disciplines (including the Major Trend Index) are nominally bullish, we’re mentally gearing up to do something in the near future that was once considered ill-advised: Fighting the Fed.
We expect much higher volatility in interest rates this year as the market grapples with the prospect and timing of the Fed’s first rate hike. Our base case is for the Fed to raise rates in the third quarter. There are various reasons for the Fed to be patient. Inflation will be the biggest one. The threat of oil-related risk contagion is certainly real. We are concerned that equities have not fully priced in this threat.
More upside surprises are still likely and, despite the disappointing jobs report, the overall economic picture still supports a September taper. The improving economic picture is not just happening within the U.S., but in other major countries. We still believe the upside for the U.S. 10-year is limited.