Stocks Ripe for Correction?

By Scott Chan, Leeb's Market Forecast

U.S. stocks declined over several days this week after the S&P 500 last week set an all-time high. Concerns that the Federal Reserve may hike interest rates sooner than expected are to blame. A research letter published by the San Francisco Federal Reserve Bank states that investors may be under-appreciating the “extent to which short-term interest rates may vary with future news about the economy.” Specifically, the piece suggests that the public may be expecting more accommodative policy than do Fed decision makers.

We have long argued that we think Janet Yellen and company will hold off from raising rates until at least mid-2015 and we have not seen anything to convince us otherwise. The Fed Chair has repeatedly reiterated that slack remains in the labor market and that inflation expectations remain stable, basically making the case for keeping rates at their current rock-bottom levels.

The latest data supports the Yellen’s stance—and our opinion, too. Last Friday, the Bureau of Labor Statistics reported a disappointing payrolls increase of 142,000 for August. It was the worst monthly performance in 2014, ending a 7-month streak of gains of 200,000 or more. Meanwhile, the latest reading from the Personal Consumption Expenditures—the Fed’s preferred inflation gauge—is only 1.56 percent, well below the Fed’s 2-percent target. The Core PCE index, which excludes food and energy, actually declined slightly to 1.47 percent.

But with the market hovering around its all-time high and valuations stretched, it doesn’t necessarily need a big reason to undergo a modest correction. Trading at 16.7 times projected forward-year earnings, the S&P’s highest valuation in nearly 5 years. It’s also been a remarkable smooth ride: Before the streak ended this week, there had been no upward or downward moves of more than 0.5 percent for the blue chip index in 14 consecutive days, the longest such stretch since 1969, according to data compiled by Bloomberg.

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The views expressed here are that of myself or the cited individual or firm and do not constitute a recommendation, solicitation, or offer by myself, D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.

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