Investors looking for something to worry about as stocks trade near record highs might consider this: Equity valuations are above-average but fear readings are low and signal complacency.
So says Patrick Adams of Choice Investment Management.
He notes that with the stock market back at new highs after taking out prior records from early March, the market appears to be a little ahead of itself at the moment.
“The markets are back to their old highs again that was last reached back in early March of this year, which puts the market in an overbought condition,” he told clients in a research note.
In pre-market trading, the S&P 500, which heads into today’s session just 0.4% off Friday’s record closing high, was down 5 points, or 0.2%.
What concerns him is the fact that the price-to-earnings ratio of the broad Standard & Poor’s 500-stock index, based on 2015 estimated earnings, is at 17.7 earnings heading into today’s session. The S&P 500 closed last night at 2108.92, or 0.4% below Friday’s record close.
And at a time when the market is trading above its historical average P-E, a closely followed Wall Street fear gauge, dubbed the VIX is trading at around 13.1, which is nearly 33% lower than where it was at the start of the year and a whopping 58% lower than its 52-week high of 31.06 from last October.
The five-year chart below of the fear gauge shows just how low the current fear reading is:
A low VIX reading is a sign of complacency, or a lack of fear. It’s also a sign of high confidence and optimism among investors — which is not always a good thing.
“When P-E ratios are high and sentiment, or the VIX, is very bullish (or positive), it is generally a negative indicator for the market,” Adams noted.
Adams also warned that the market is due for a correction, defined as a drop of 10% or more from a high.
“The last significant pullback for the markets occurred four years ago,” Adams wrote. “We have not had a 10% correction since 2011. Generally, a 10% correction occurs every year.”
You’ve been forewarned.