Record highs are no longer justified

17 October, 2017

“Since Election Day on November 8, the Stock Market is up more than 25%, unemployment is at a 17 year low & companies are coming back to U.S.” Donald Trump

Indeed, the Dow Jones Industrial Average and the S&P 500 rose by more than 25% and 20% respectively since November 8. President Trump gives credit to himself, and no one can blame him because fundamental data cannot justify current levels.

All the three major U.S. indices reached new record high yesterdays, but investors just got used to it and record highs are no longer making headlines. For those who have been waiting for a correction to buy the dips have missed the opportunity. The threat of nuclear war, expectations of higher interest rates, hurricanes, and terrorist attacks all failed to pull markets from record levels. 

Equity strategists have been forced to adjust their year-end target higher for U.S. indices although little justification is provided. Valuations are becoming incredibly overstretched, yet investors do not seem to worry.

Forward 12-month P/E ratio on the S&P 500 rose above 18 this week for the first time since mid-2002. Although multiples remain below the forward peak P/E ratio of 24.4 tested during the bubble, it’s still much higher than 10-year or 20-year averages of 14.1 and 16.  This means investors are paying more for less.

It looks to me that speculation and greed are what driving the current bull market which could be an indication of the latest stages of an up trending market. However, it is not a wise decision to sell uptrend market; speculation might continue to drive stocks higher especially if earnings surprise to the upside.

Nobody knows when or what will trigger a sharp correction or a bear market. Timing the market is almost an impossible mission. However, for investors who would like to remain invested in the current bull market, my advice to them is to buy protection. CBOE’s Volatility Index (VIX) is currently trading below 10 (-29.5% YTD) which means options prices are relatively cheap. The downside to buying a put option is that it expires and the investor loses the premium paid, but given that things look crazy the reward of buying put options is higher than the risk involved.

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