February 23rd Weekly Market Update

Thanks to some help from the Greece agreement reached last Friday, the S&P 500 and Dow Jones Industrials Average ended last week at new record highs, while the NASDAQ has moved to within 50 points of the 5000 milestone. The market’s continued ascent has caused some to ask if the stock market reflects excessive optimism.

One way to respond to that question is to look at valuations. On both trailing earnings and forward earnings estimates, we believe price-to-earnings (PE) ratios — both between 17 and 18 — are slightly rich, but not high enough for us to change our positive outlook for U.S. stocks for 2015. (For more on our 2015 stock market forecasts, please see our Outlook 2015: In Transit publication.) Another way to gauge optimism is to look at market surveys, such as the percentage of bulls from the American Association of Individual Investors (AAII), which at 72% is only slightly above the long-term average range of 60 – 65% and not excessively optimistic. Finally, earnings and economic surprises also indicate that investor expectations remain reasonable.

Economic data in the United States have been missing expectations more often than exceeding them in recent weeks, suggesting expectations have been pulled down as stocks reached new highs. The Citigroup Economic Surprise Index, or CESI, tracks how the economic data are faring compared with expectations. The index rises when economic data exceed economists’ consensus estimates and falls when data are below estimates. The index’s most recent reading of -48 marks its worst level in 2.5 years, well below the 10-year average (+2.8), and near levels where a reversal would typically come. The index has been dragged down by several factors, including the energy downturn, the West Coast port shutdowns, sluggish growth overseas, and the strong U.S. dollar. For example, among the reasons cited for the shortfall in the Institute for Supply Management Manufacturing Index for January (53.5 versus 54.5 expected) included the impact of lower oil prices on manufacturers, the export drag from a strong U.S. dollar, and sluggish growth overseas. Economic forecasts do not appear to reflect excessive optimism, even as stocks power to new highs.

For the full article: ARE EXPECTATIONS TOO HIGH?