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Nicklaus: Stock market is sleepwalking past potential problems

09 March 2017

(St. Louis Post Dispatch) 

“We’re not saying the market is getting ready to tumble,” say John Meara, president of Argent Capital Management in Clayton. “It’s just that the shock absorber of undervaluation is gone.”

March 6, 2017 (David Nicklaus)

Shhh. Don’t wake the stock market. It appears to be sleepwalking, and may get upset when it realizes how little explanation there is for the distance it’s traveled.

Stocks have risen 11 percent since Election Day, largely on hopes that lower taxes, deregulation and infrastructure spending will supercharge corporate profits. Never mind that bizarre allegations of espionage are distracting Washington from substantive matters, or that Congress is a long way from consensus on a tax plan.

The market’s steady march is unusual, to say the least. The Dow Jones industrial average set 12 straight record highs in February, the best such streak in 30 years. The Standard & Poor’s 500 went 66 days without rising or falling at least 1 percent, the longest placid period in four decades.

Traders are shuffling past topics that used to send them into a tizzy. The market even closed higher on Friday, when Federal Reserve Chair Janet Yellen indicated that an interest rate increase is likely this month.

Such patterns worry Joe Terril, president of investment firm Terril & Co. in Sunset Hills. “We’ve priced in the good things that we think Congress and the administration are going to do,” he said. “I’m not sure people have priced in what interest rates could do.”

Higher rates tempt savers to shift money out of stocks and into interest-bearing bonds or bank accounts. They also hurt corporate profits by raising borrowing costs. Utilities are already starting to feel the pressure; the Dow Jones utility index is up just 4 percent since Election Day.

“The stock market has had a great run because there’s been no alternative,” Terril said. “The alternative is on its way back.”

Having bet on new business-friendly policies coming out of Washington, investors seem willing to wait and see how those policies turn out. With each new high in stock prices, though, the potential for disappointment becomes greater.

“We’re not saying the market is getting ready to tumble,” says John Meara, president of Argent Capital Management in Clayton. “It’s just that the shock absorber of undervaluation is gone.”

By Meara’s reckoning, stocks were appealingly cheap for most of the last eight years. The recent run, he figures, has taken them out of the bargain bin.

The S&P 500 index sells for 18 times this year’s expected earnings; Meara figures that ratio should be 17.5. The market looks ahead, and profits next year might get a boost from lower taxes, so he’s not saying stocks are overvalued. He calls them fully valued.

That means investors shouldn’t expect further big gains. “It’s not like we are overheated,” he says, “but single-digit earnings growth will translate into single-digit market returns.”

Bull markets don’t die of old age, but the current one is getting long in the tooth. It celebrates its eighth birthday this week, making it the second most durable in history.

Until recently, at least three engines were pushing it higher: favorable valuations, low interest rates and a gradually improving economy. The first of those engines has been switched off, and the second is about to be. That leaves the market more dependent than ever on sound economic policies.

“Historically, there’s a 10 percent correction about every year and a 20 percent drop every couple of years,” Meara said. “We’ll have one again, we just don’t know when.”

So, we’d better watch this sleepwalker carefully. They can be disoriented and cranky when they wake up.