Sell Everything . . . Do So at Your Own Peril

Two questions recur in my email more than most: Are stocks overpriced? Should I sell my stocks?
The questions are understandable.
The bull-market run commenced in March 2009. The S&P 500 Index had bottomed at 683. Here we are, 104 months later, and the S&P trades at 2,580. The S&P has nearly quadrupled its value.

Looking Back on Bull Markets

A 104-month run is long in the annals of bull markets. It’s practically a marathon. We’ve seen only one longer run among bull markets. This occurred during the 1990s tech revolution.
Stocks ran for 113 months — October 1990 to March 2000 — without experiencing a 20% decline in general market prices (which would end the run). The S&P 500 quintupled over 1990s. It crashed to start the 2000s. Earnings growth finally relented.
As I write, 91% of S&P 500 companies have reported third-quarter earnings. FactSet data show that 74% of the companies have reported earnings that beat the consensus estimate. S&P 500 companies are on track to post record earnings growth.

Earnings Growth Matters

What’s more, the growth is legitimate. Reported earnings growth is more than a byproduct of share buybacks that concentrate earnings on fewer shares.
Activity trends higher. S&P 500 companies are expected to post a 5.6% revenue increase year over year. Companies are selling more, and they’re earning more.
More growth is expected. The analysts FactSet surveyed expect 10.5% year-over-year earnings growth in the first quarter of 2018. They expect 10.1% year-over growth in the second quarter.
The analysts will miss the mark on their earnings prognostications. They always do. They’re on spot with the trend. Earnings growth will continue.
Investors will also pay more for the growth. The market is pricey from a historical perspective. The forward 12-month P/E multiple for the S&P 500 is 18. The multiple is above the five-year (15.6) and the 10-year (14.1) average multiples.

No Two Alike

I’m hesitant to say this time is different. But it is different. It always is. No two market epochs are alike.
Unlike the bull-market run of the 1990s, this run is marked by aloofness as much as anything. Euphoria, which ended the last bull-market run, remains suppressed. The latest reading of the American Association of Individual Investors (AAII) Sentiment Index survey backs my contention.
Of the individuals surveyed, 29.3% claim to be bullish, 35.2% claim to be bearish. The historical average is 38.5% and 35.2%, respectively. When last bull-market run ended in March 2000, bullish sentiment was 75%.
Interest rates remain low, even if the Federal Reserve would like them high. A 10-year U.S. Treasury note is priced to yield 2.35%. It was priced to yield 2.55% to start the year.
Low interest rates support higher stock value. Lower interest rates — lower long-term rates in particular — produce higher present values.
Tax reform would help keep the bull running.
President Trump’s Treasury Secretary Steven Mnuchin has said that if no tax reform occurs, stock prices will fall, and, fall by a “significant amount.” If tax reform passes, earnings and stock prices are destined to rise, according to the Mnuchin doctrine.
Mnuchin’s stock-market soothsaying is a political ploy: He’s pressuring the opposition to acquiesce. We expect the stock market reaction to tax reform to be less binary.
Investors were burned earlier this year anticipating tax reform. Reform failed to materialize, stock prices fell.
If tax reform fails again, stocks should hold form. Investors were fooled once, they won’t be fooled again (at least this year).
If Congress passes tax reform, Mnuchin will prove right on his outlook for a stock-market rally. A lower corporate income tax rate and one-time repatriation tax holiday will raise investor enthusiasm for stocks.
We have a stock market imbued with low investor euphoria, low interest rates, and high earnings growth. A market correction wouldn’t be impossible when such conditions prevail, but it would be improbable.

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