Is the S&P 500 looking expensive?

The S&P 500 is in uncharted territory as a QE binge by the Fed sends investors searching for yield. Since the beginning of the year the index has climbed over 15%, sending it to its highest level ever. The run higher in US equities has been primarily fuelled by a search for yield and the notion that the US economy is on a path to recovery on the back of QE3. Whilst we don’t dispute either of these premises, we do raise an eye at the height at which US equities have been allowed to soar, especially given how expensive they’re looking by some metrics (eps, revenue).

If one of the pillars of strength for the index starts to erode, or at least crack, then we may see a natural correction in price. The pillar in question is the notion that the US recovery remains strong. While we retain our view that US growth is heading higher in the long-term, recent economic data hasn’t been living up to expectations.

Looking at the chart below we can see Bloomberg’s so-called US surprise index, which shows the degree to which analysts under or over-estimate economic data, is in negative territory, implying that US economic data has broadly been worse than expected this year. At the same time, the index has risen by over 15%.

This positive sentiment is largely due to the Fed keeping its foot on the QE gas pedal. History shows us that once the Fed takes its foot off, then a corresponding rise in equity prices usually stalls. The Fed, therefore, stated that it will keep holding down the yield curve as long as US economic data suggests it is needed. In other words, QE3 isn’t going anywhere until the US economy shows more signs of life. Still, this creates the possibility of an over-correction to the upside as long as the Fed continues to print money and the US economic doesn’t substantially improve, especially if volume continues to dwindle.

Source: Forex.com

27.05.2013