Editor’s note: Following publication of this article, the markets sold off hard on Thursday, Sept. 3, with major U.S. indexes down from 2.8% to 5%. The commentary by some of the analysts quoted here on “overbought” conditions in the market was right on the money—at least in the short term.
The market adage “Sell in May” certainly has not been working in 2020, much to the delight of bullish and long-only investors.
According to MarketWatch, the market closed on Monday (Aug. 31) with “the strongest August return in decades.”
August’s increase of 7% for the S&P 500 comes on top of a gain of 1.8% in June and 5.5% in July.
Fox Business wrote earlier this week,
For the year, the Dow finished August barely in the red, the S&P 500 gained 8.3%, and the NASDAQ Composite Index was up over 31%. Of course, some have noted that the rally has been concentrated in a few top tech names with outsized gains, with many of the S&P 500’s component stocks (and sectors) still negative for the year.
Bespoke Investment Group published two charts showing the highs and lows of the market for the past month and year.
The first shows how “the relentless nature of the S&P 500’s rally in August has been historic.” Bespoke notes,
Source: Bespoke Investment Group, data as of 8/28/2020
Figure 2 shows relative sector performance through Aug. 26. Bespoke says,
Source: Bespoke Investment Group
The market’s current level and valuation, especially in light of still-elevated unemployment, an uncertain GDP outlook, and the sector divergences shown in Figure 2, is under much scrutiny.
National Securities’ Art Hogan has warned that a key technical trend suggests the S&P 500′s record win streak is running into trouble. “We’re overbought in the S&P 500 as an index in the short run,” the firm’s chief market strategist told CNBC’s “Trading Nation” on Friday. “It moved higher really quickly.”
Hogan, says CNBC, uses a chart of the relative strength index, otherwise known as the RSI, to build his cautious case. “When that sits around 50, you’re basically neutral. When it gets to 30, you’re oversold,” he said. “And, when you get to 60 or 70, you’re overbought. We’re currently at about 75 on the S&P 500. So, we’re clearly overbought.”
Hogan says that the technical outlook, combined with any number of potentially negative headlines, could see the S&P 500 drop 5% to 10% in the September and October time frame. “Nothing draconian, but certainly an opportunity to say there’s a better buying opportunity in front of us if we still have cash on the sidelines,” he said.
CurrentMarketValuation.com tracks four valuation indicators continually. As of Aug. 28, two of these were rated as “Overvalued” (S&P 500 P/E Ratio Model and S&P 500 Mean Regression Model) and two were “Strongly Overvalued” (Yield Curve Model and Buffett Indicator Model: a ratio of total U.S. stock market valuation to GDP).
The site noted recently for one of these models, “The Buffett Indicator (named after Warren Buffett, who claims this as a favorite macroeconomic indicator) is the ratio of total US stock market valuation to GDP. This is currently 67% higher than its historical average, indicating the market is currently Strongly Overvalued.”
Interestingly, the market’s 2020 surge since the bottom in March appears to have caught many major Wall Street analysts by surprise. Bespoke Investment Group charted the current analyst calls for the S&P 500’s year-end finishing value, showing 13 of 17 analysts still with projections under the market’s current level.
Source: Bespoke Investment Group
Canaccord Genuity’s Tony Dwyer, a frequent contributor to Proactive Advisor Magazine, addressed the issue of valuations in a recent client note. His comments, part of a more comprehensive analysis, reflect the highly unusual nature of the current market environment:
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