Stock Market: Waiting for the Other Shoe to Drop

With stock indices hitting record highs and the bull market continuing its seven-and-a-half year run, you might expect investment gurus to be content and happy. But nothing is ever straightforward in the investment world. Some analysts are beginning to worry that things might just be too good to last much longer. Here are some of the key factors that are driving the markets.

Mature Market and Elevated P/E Ratios

The fact that the bull market has lasted this long – to become the second oldest bull market ever – makes some commentators believe we are due for a reversal. Stocks are considered to be expensive. Many analysts use a price to earnings ratio known as the Shiller P/E ratio to determine when stocks may have reached inflated prices and a bubble may be in the making. Using the Shiller measuring tool, which looks at stock prices against 10 years of averaged corporate earnings, P/E ratios reached 27.3 in August. Many analysts think that any P/E ratio of 27 (or more) suggests a meaningful correction is on the horizon, and that when stock prices become this expensive (on a P/E basis), that there is a real possibility of a reversal. This being said, bear in mind that elevated P/E ratings are regarded as a warning of elevated risk, not as a call to immediate action.

Positive Economic Data

Despite the general handwringing, there has been good news in the manufacturing sector. New orders for manufactured capital goods rose in July for the second month in a row – a sign that business spending is beginning to rebound. Winners in the manufacturing sector included machinery, primary metals, fabricated metal products, computers and electronics. However, economists are forecasting tepid growth for U.S. business investment in general in the third quarter, citing the uncertainty created by Brexit and the lead up to the Nov. 8 presidential elections. Demand for durable goods was brisk in July with orders increasing 4.4 percent. Inventories also increased in July, following a dismal six-month decline. In the labor market, the news was positive, too. Weekly jobless claim benefits have been below 300,000 (a benchmark associated with a healthy labor market) for an impressive 77 consecutive weeks.

Wild Cards

Several factors could hurt the markets.

• In the race for the White House, pundits are expecting Clinton to win. If the race narrows and a victory for Trump looks possible, the markets probably would react adversely. Wall Street is leery of a Trump presidency, fearing it might unleash trade wars and economic and political instability.
• The investment community currently expects an interest rate increase no sooner than December. If during the Jackson Hole Meeting in late August, Federal Reserve Chairwoman Janet Yellen hints that an increase might come sooner, the markets might react badly.
• The rally in oil prices was welcome news, but now industry observers are worried that the uptick might not continue. When oil is below $40 per barrel, the impact on a multitude of oil- and gas-related businesses is significant.

The commentary above is general in nature and is not intended to replace advice from expert tax and investment professionals.