Investment great Warren Buffett once said, ‘Be fearful when others are greedy,’ but according to a team of equity strategists at Citi, investors are pushing back against the idea that the S&P 500 (INDEXSP:.INX) may be growing faster than earnings warrant. Tobias Levkovich, Lorraine Schmitt, and Christina Wood released a strategy document after being told by numerous clients in the same week that the S&P 500 would grow by 30 or 40 percent this year, and that there are not viable investment alternatives.
See: S&P 500 Valuation Spread at 25 Year Low
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S&P 500: Analysts say to use common sense regarding QE
“While we remain long-term bulls, with a mid-year 2014 target of 1,825 for the S&P 500 (INDEXSP:.INX), we suspect that share prices are a bit ahead of themselves,” they wrote. The issue isn’t whether the economy is doing well. As they point out if growth is strong it will withstand the end of qualitative easing, and if it’s not then tapering will simply be postponed. There is every reason to be optimistic in the long term, and the team even puts the S&P 500 at 1825 this time next year, but in the short run there could easily be a correction.
“Intra-stock correlation has plummeted and the National Association of Active Investment Management’s readings also are registering some warning signals. The client commentary is now pushing back against our caution when they were adamantly pushing back in June 2012 against buying,” the group explains.
The rationale is appealing. If you expect the S&P 500 (INDEXSP:.INX) to grow by 30 percent this year, then it doesn’t matter if it’s already gone up by 20 percent, there’s still plenty of money to be made. Investors that stayed away before Q2 earnings started coming in have missed out on lots of growth, reinforcing the idea that you need to get in while you still can.
Approaching market peaks are a time to avoid ‘herd’ mentality
But it’s exactly this herd instinct that Buffet is warning against. When everyone agrees that the market will continue to rally or continue to drop, they’re usually wrong. The panic/euphoria model, which measures investor sentiment, is strongly contra-indicative of future earnings, and that sentiment has spiked recently. It hasn’t yet hit the ‘euphoria’ bright-line, but it’s close enough that investors might want to check their emotional state before buying into a hot stock.
But knowing that a dip is likely and knowing when it will happen are different matters entirely. “The biggest challenge thrown at advisors from the investment community is to tell them the catalyst that will cause a correction,” the report explains. But with share prices and sentiment rising faster than earnings, it only seems reasonable to expect them to come back down.