The 4 Numbers That Matter to the Stock Market Right Now

The 4 Numbers That Matter to the Stock Market Right Now

iStockphoto/The Fiscal Times

The fireworks are long over, at least as far as the Fourth of July festivities are concerned. But while last week’s strong jobs report may have fueled the Dow Jones Industrial Average’s explosive burst above the 17,000 mark for the first time, it’s not the only data point that matters to the market and to investors.

Related: The Dow Rockets Above 17,000

The fact that both the Dow and the S&P 500 index closed at record highs before falling for two straight sessions after the jobs report serves to underscore the importance of several other factors: bits of data that will end up dictating how long – and whether – the two market barometers linger at their current lofty levels.

Earnings: 6.3 Percent Growth Forecast
We’re heading into second-quarter “earnings season” – it kicked off officially on Tuesday with Alcoa’s better-than-expected quarterly results – with stocks still priced for perfection. That will mean that any misstep is going to be punished, perhaps disproportionately. And as previous earnings seasons have demonstrated, there have been missteps and shortfalls, if not always when it comes to the bottom line then with respect to growth in sales or because of a gloomier-than-expected outlook.

Right now, Thomson Reuters I/B/E/S projects that second quarter profits for companies in the S&P 500 are on track to grow just above 6 percent compared with year-ago levels, with technology and energy companies leading the charge higher. The ratio of negative to positive forward guidance is lower than it was a year ago — but still significantly higher than the long-term average, making it a kind of mixed signal.

Related: Eye on Earnings After Record Stock Performance

Valuation: P/E Ratio Is 20
Admittedly, trying to pin a valuation on stocks is like trying to pin Jell-O to the wall. It all depends on what you use for the “E,” or earnings, part of the price/earnings ratio. If you’re simply using the 12 months of most recently-reported earnings, the number today is roughly 20; in other words, an investor picking up the S&P 500 is paying about $20 for every $1 of earnings his portfolio generates. Or you could use operating earnings, in which case the ratio would fall to $18.27 per $1 of operating earnings. Some folks prefer to look at projected earnings — because, after all, when you invest in equities, you’re betting on their future performance. By that calculation, you’re only forking over $15.70 for every $1 of earnings.

On the other hand, you could scare yourself witless by using the long-term P/E ratio developed by Yale University economist Robert Shiller. Using a decade’s worth of inflation-adjusted earnings to come up with the “E” part of the equation, the Shiller P/E seeks to identify bubbles in the making — and right now it registers 26.18. That’s well below the 1999 peak of 44.20, but still uncomfortably far above the mean of 16.55 and the median of 15.93.

If that string of numbers has your head spinning, here’s the bottom line: All of these valuations are now well above their long-term averages. That’s not to say that over-valuation can’t persist for prolonged periods — that’s precisely what happened back in the late 1990s, and there are plenty of other examples of sector-specific market distortions persisting for years.

It does mean, however, that a shock leaves the market more vulnerable. At these levels, a selloff isn’t automatically going to trigger fresh buying from value investors who are just itching for an opportunity to jump in and pick up some bargains. In most cases, we’re far from a point where that would happen. Consider the fate of the technology and biotech stocks hit hardest by the selloff at the beginning of the second quarter: They were the most over-valued members of their sectors and many are far from recovering lost ground.

Interest Rates: 2.57 Percent
What happens to interest rates is critical to the bond market – and thus to stocks, as their single largest alternative asset class. Over the course of June, the rate on the 10-year US Treasury climbed to 2.57 percent from 2.47 percent; while that is still well below the 3.03 percent level at which the benchmark Treasury traded at the end of 2013, it’s still far higher than the 1.75 percent level at the end of 2012. That reflects the Federal Reserve’s gradual removal of stimulus by dialing back its monthly purchases of mortgage-backed and Treasury securities. It also is starting to reflect the longer-term prospect of the Fed actually raising key lending rates for the first time since the financial crisis and the recession, even though Fed officials made clear last month that that isn’t likely to happen until next year at the earliest.

When interest rates rise, the value of existing debt investments or other fixed-income securities fall as the old interest rates look less appealing. In that kind of environment, investors are more likely to favor stocks. Plus, as long as the Fed is looking at an eventual tightening and a longer-term brighter outlook for the economy (forget about that lousy first-quarter GDP reading — it was an outlier), the odds increase that corporate earnings will also rise, making stocks relatively more appealing anyway. Some of that may already be priced into today’s equity valuations, but there may be room for more, depending on the economic data.

Mutual Fund Flows: -$15.1 billion
People fuss and fret over the eerie calm in the market; the lack of trading volume and volatility. Here is what unnerves me, though. During the second quarter, as stocks recovered from their early April stumble and a generally blah beginning to the year, individual investors seem to have fled in droves. As the S&P 500 average went on to rally 4.66 percent for the quarter (and as bond yields fell), investors yanked an estimated $15.1 billion from U.S. equity mutual funds, according to The Wall Street Journal, while putting $28.5 billion into bond funds instead. Fearful? Irrational? Paying too much attention to all the buzz about those high valuations?

Ultimately, for all the anxiety and focus on the negative, the stock market keeps chugging higher. And while some of the metrics suggest that it has become more vulnerable, others suggest that there is room for the market to hold its own. Certainly, Laszlo Birinyi, who has watched market cycles come and go, isn’t anywhere close to being ready to pulling the plug on this fireworks show just yet.

“We are in a bull market and therefore the positive case gets the benefit of the doubt,” he wrote in a note to clients last week, reminding them that this particular bull market isn’t an ordinary, average, typical or normal one. That means, he adds, “many approaches or metrics are not useful or applicable.”

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