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TSP Talk: Valuations vs. stimulus

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Stocks rallied again yesterday with the Dow rallying 260-points and the Nasdaq leading the way with a gain of nearly 2%. Small caps lagged a bit but still had another solid day. Bonds were flat, as was the dollar. The bulls are loving it but the question I keep asking is how many times can the market rally on the stimulus? It doesn't seem like a real market, but it continues to work.

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Stocks were down modestly during the week that Trump was inaugurated in 2017, and they were down sharply the week of, and the day that Obama was sworn in back in 2009. Perhaps there is no correlation but stocks have been up big so far for Joe Biden's inauguration day, and with two days to go, up sharply for the week. It may have been in sympathy with the tremendous stimulus that is expected during his first few months in office, but now comes the post-inauguration market where I have been touting a possible sell the news reaction.

Some of my sell the news inauguration theory was based on prior reactions, and as we talked about yesterday - going back to 1950, so I was a little surprised by the strength yesterday, but today is another day, and we'll see how that theory goes now that the pageantry is over.

After the tremendous run we have seen over the last nine months, stocks that were beaten down have not only come back to where they were before COVID, but have flourished to new highs, and in the case of some of the 2020 biggest winners like Tesla with its P/E (price to earning ratio) at a staggering 1626, or Netflix 96, Amazon 95, Zoom 266, Peloton (inf., negative earnings), they have exploded.

As a whole the trailing P/E ratio of the S&P 500 is just under 40. That's quite high historically, yet stocks continue to move higher almost every day. Only before the dot com bubble bursting and the pre-financial crisis did we see a higher P/E ratio.

The average P/E/ ratio of the S&P 500 going back to 1950 is 18.24. The current 38.58 trailing P/E put it in the 97.8 percentile, meaning it's only been priced higher compared to it's earnings, 2.2% of the time.

Perhaps the reason for all of the buying is the projected forward looking P/E being 25.63, and that's because of the expected post COVID growth in 2021, but even that is well above the historical average.

Perhaps 0% interest rates and unlimited stimulus can keep the market rising beyond normal valuations, but it is also going to continue to beat down the dollar. I don't know how long this game can be played, but I want in. I just need a meaningful pullback to buy... is that too much to ask?

The S&P 500 (C-fund) was up big again yesterday, adding more icing to the late 2020 rally. This one has lasted almost three months now, but even in a year like 2020, when stocks raced off those March lows, there were meaningful pullbacks for those who waited.

The market always looks the best near its tops. Not that we know when a top will be put in, but severe declines can manifest from what look like invincible charts. Here are two charts, one from 2020 and the other 2018, where we saw explosive rallies into January, and what eventually occurred. We did get a little bit of a warning on these as we saw some of the trading channels break before the major damage was done.

In the case of the high flying DWCPF (small caps / S-fund) we did already see one of those channels break (blue dashed support line), and like the 2020 chart above, it ran back up to test the bottom of that old broken support line before failing and dropping down sharply again.

BND (bonds / F-fund) remains in a tight range, perhaps coiling up for its next big move. The open gap may be indicating that it may want to move higher.

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Thanks for reading. We'll see you back here tomorrow.

Tom Crowley

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