Why the stock-market rally may be petering out

Despite the appearance of momentum, the forces sustaining the market could be fading

Why the stock-market rally may be petering out
The US stock market has had a tremendous bull run, with the S&P 500 recently reaching record levels while other developed markets outside North America remain below their pre-crisis highs. And while the market appears to be going strong, a few indicators suggest the beginnings of a slowdown.

The first red flag: low cash levels. “[P]rivate client cash as a per cent of total investable assets have now fallen to a record low according to Bank of America Merrill Lynch data,” Martin Pelletier, Portfolio Manager and OCIO at TriVest Wealth Counsel, wrote in a recent think piece on the Financial Post.

And it’s not just for private clients. Citing a report from Business Insider, Pelletier said mutual funds are sitting on cash balances of 3.3%, while a Citigroup survey of institutional investors found average cash levels at 2.25% of assets under management. A net cash outflow of $300 billion among US corporations, as reported by Cornerstone Macro, is reportedly the largest deficit on record.

The next warning sign is a lack of risk. According to Pelletier, the seemingly unstoppable urge to buy among investors has sent volatility crashing: out of the 39 times since 1990 when the VIX has closed below 10, 30 occurred this year, and 15 happened in the past month. “[T]he Dow Jones Industrial Index’s Sharpe ratio, a measure of return per unit of risk, is at 4.5 – statistically higher than 99.7 per cent of all readings since 1900, as cited by Bloomberg,” he said.

Finally, there’s the lack of deals. The S&P 500’s rise of 70% over the past five years despite an earnings advance of only 10%, Pelletier said, is because of a disproportionate focus on the tech sector over traditional sectors. “Many are now willing to pay more than 60 times earnings for certain tech firms while applying a more modest 15 times multiple for energy companies and 20 times for banks,” he noted.

Citing an analysis from Factset, he said the S&P 500 is trading at 22.3 times the trailing 12-month P/E, compared to a 10-year average of 16.9 times. “We don’t think this is sustainable unless the tech sector can start to transform revenue growth into actual earning,” he said. “That said, even on a median price-to-revenue basis the S&P 500 is now the most expensive it has ever been.”

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