By Wallace Witkowski, MarketWatch
SAN FRANCISCO (MarketWatch) -- Stock indexes rallying to new
highs have put investors on alert for a correction. Now they have
something else to worry about: Too many individual stocks touching
highs.
The S&P 500 Index (SPX) rose 2.1% last week to close at a
record of 1,667.47 Friday, its 16th record close this year.
Similarly, the Dow Jones Industrial Average (DJI) rose 1.6% on the
week to 15,354.40, its 21st record of the year. The major
benchmarks, including the Nasdaq Composite (RIXF), have made a
nearly unchecked 16%-17% gain for the year.
It's not just the indexes that are stretching for the
stratosphere.
Also in the past week, more than half the stocks on the S&P
500 touched new 52-week highs, with 141 of those occurring on
Friday alone, according to an analysis of FactSet data. Another 128
companies reached new 52-week highs earlier in the week.
"The number of people I've heard justifying the valuation has
been mind boggling," said Andrew Wilkinson, chief economic
strategist at Miller Tabak & Co. "The complacency is now
incredible but nobody knows what the catalyst will be for a
setback."
The CBOE Volatility Index (VIX), or so-called "fear index"
closed down nearly 5% at 12.44 Friday, its lowest close since
mid-April. The index has fallen 31% year to date, and current
levels seem more at home in 2004 to 2007 than any other time in the
last 10 years.
Optimism, whether blind or not, is so rampant, short sellers are
particularly miserable. Some of the most-heavily shorted stocks are
outperforming the S&P 500.
"The bulls don't have to try too hard because previous bearish
forces are adding fuel to the fire, propelling the market higher,"
Wilkinson said.
What has been missing from this rally is volume, owing to the
slow grind of stocks higher, he said. Volume is about 14% lighter
this May from the year ago period, according to Barclays.
Similarly, second-quarter volume is nearly 9% off from last
year.
Investment strategists often like to see a rally shared by a
wide number of stocks. This breadth should give support to further
gains, the thinking goes. But such widespread fortune has also been
the precursor to pullbacks.
On Wednesday, 538 stocks on the NYSE reached 52-week highs, the
largest number since Nov. 2, 2010, according to Jonathan Krinsky,
chief technical market analyst at Miller Tabak,
Krinsky cautions that the last time there were that many 52-week
highs on one day, the market experienced a 4.5% correction.
Similarly, surges of 600 or more NYSE-listed companies hitting
52-week highs in April 2010 preceded a 16% correction, which
included the "flash crash" of that May, and a day of 600-plus NYSE
stocks reaching 52-week highs on Oct. 3, 1997 -- when the S&P
500 was up 33% for the year -- was followed by a 13% decline over
the next few weeks.
"While a high reading of new 52-week highs should hardly be
considered bearish, we simply want to highlight that a 'surge' in
the reading is not necessarily the most bullish indicator either,
especially following a sustained advance," Krinsky said in a recent
note.
Stock prices near record highs. But are they overpriced?
The real question then becomes whether stocks are overvalued or
not. Here, data on one popular measure--price-to-earnings
ratios--has something for both the bulls and the bears.
The S&P 500's forward 12-month P/E ratio is 14.4, according
to John Butters, senior earnings analyst at FactSet. While that's
higher than the 5-year average of 12.9 and the 10-year average of
14.1, it's less than the 15-year average of 16.5.
But even that might be misleading. Back on Oct. 9, 2007, when
the S&P 500 hit a record high before the financial crisis, the
forward P/E ratio was 15.2, below the 5- and 10-year averages of
15.7 and 18.6, respectively, Butters said.
Relatively low valuations are mostly the product of high profit
margins, cautions Russ Koesterich, global head of investment
strategy for iShares at BlackRock. While both forward and trailing
price-to-earnings ratios for large-cap stocks are below long-term
averages, corporate profits currently make up about 10% of U.S.
GDP, compared with a long term average of 8%.
"There's the implicit assumption that margins will remain
elevated, Koesterich said. "If you think margins will revert to
normal then some of those earnings are not sustainable."
FOMC minutes on deck
This week, attention will once again fall on the Federal Reserve
as minutes from the central bank's last Federal Open Market
Committee are released. While the Fed has stated it will more or
less stay the course with its $85-billion-a-month in asset
purchases, stocks are setting new highs even as the call for
scaling those purchases back has been gaining momentum.
Miller Tabak's Wilkinson said the market appears to have a grasp
of what the Fed is trying to do with quantitative easing and that
gradual improvements in employment and housing are giving the
economy enough inertia to more forward on its own soon.
"When you get a child riding a bike with the training wheels on
and they don't need them, it looks a bit silly," Wilkinson
said.
Also, low inflation below the Fed's 2% target gives the Fed a
lot of latitude in which to act, said Blackrock's Koesterich. The
real question, he said, is how investors act when the Fed starts
taking it's foot off the gas.
Earnings season winds to a close
Next week will also see the last of the Dow industrials
reporting earnings along with much of the rest of the S&P
500.
So far, 463 companies in the S&P 500 have reported first
quarter earnings. Of those, 70% have topped Wall Street estimates
for earnings, while only 43% have surpassed estimates on revenue,
according to FactSet's Butters.
More than 20 S&P 500 firms will report this week including
Campbell Soup Co.(CPB) , Best Buy Co.(BBY) , Medtronic Inc.(MDT) ,
TJX Cos.(TJX) , Lowe's Co.(LOW) , Staples Inc.(SPLS) , Target
Corp.(TGT) , Gap Inc.(GPS) , and Sears Holdings Corp. (SHLD).
Home Depot Inc. (HD) and Hewlett-Packard Co. (HPQ) are the final
two Dow components that will report for this season.
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