Last Friday, the market closed at 2085, following a 9-day losing streak that brought the markets down by 3%. This was the longest daily losing streak in 36 years. This week the markets immediately reversed course and gained 3.7%, erasing the last 9 days of losses. The reversal was ignited by the news that James Comey would suspend the re-opened investigation into Hillary Clinton's emails, and the markets celebrated Monday and Tuesday by rising 2.5%. Then the election Tuesday night surprised the world with Trumps win. Contrary to what investors thought, the markets actually rallied on the news on Wednesday by 1.0%. The following two days were lackluster as investors were repositioning their portfolios given the surprising President-elect. So what's next?
At this junction, this is where investors differ. The bulls believe this is the start of the next rally higher. Everyone seems to be optimistic that growth will be much higher given Trumps plans. The S&P 500 stands at 25x LTM , and its hard to believe that optimism isn't fully priced in. An argument for the high valuation is that next years will be much higher. I have seen estimates from $115 per share to $140 per share. Those equate to Forward P/E ratios of 18.8x to 15.5x, still richly priced compared to long-term averages around 14x. And those estimates have been slowly adjusted downwards. It's hard for me not to possibly recognize that certain investors were going into last weekend shorting the market as we broke below support at 2100. And after the news broke over the weekend, a lot of short covering entailed, adding fuel to the large increase in the market. Not necessarily a sign that sentiment improved. I believe that's why we puttered out when we reached the max levels closer to 2170. The enthusiasm wasn't there.
I believe the following will be headwinds against the market in the coming months.
1. It's important to point out that bond yields have risen considerably this week. One of the reasons supplied as the increased valuations in the market has been a rush to dividend stocks for yield. This will continue to reverse the interest in dividend yielding stocks.
2. The Fed is most likely to raise interest rates in February. Stanley Fischer supported these claims today, indicating that a rate hike is appropriate. This will put pressure to shift the balance of equity and bonds into the bonds favor. I don't believe the market has fully priced in this change.
3. Honeymoon over. As I have discussed previously, the rearrangement of investors portfolios to allocations that appear to be Pro-Trump have begun and show why the Dow hit an all-time high, while the S&P 500 and NASDAQ were far behind. We didn't get an enthusiastic broad based rally. Simply the sectors that are 'expected' to outperform did well (banks, biotech, industrials) while the other industries suffered or remained neutral. I think that is evidenced by the letter 'A' on the chart. We peaked on the S&P 500 , but couldn't carry through as investors are most likely not going to make big bets going into the uncertain, and volatile world of President-elect Trump.
I believe over the coming weeks we will begin to retrace, probably to the 50% Fib retracement to 2000. Now there is definitely a possibility we try to retest the highs early next week, but I think the euphoria of Trump will begin to waver as he provides more clarification on his plans and economic data continues to be reported.
The letter 'A' shows that although we pierced the on the reverse, we still managed to close below it which is a short-term sign.