Broker Check

Weekly Market Update May 17, 2024

May 17, 2024

Fed Funds 5.25% - 5.5%, US Ten Year 4.422%, Oil $79.99

Inflation figures reported this week showed a very slight reduction in the inflation rate, which nonetheless further energized a May rally in stocks being led by Artificial Intelligence-oriented technology stocks. The April 3.4% CPI rate, down a tenth of a point from March, was enough to remove the threat of a hike in Fed Funds and increase the chance of a rate cut in September to 67%.

There is market adage, “Sell in May, and Go Away,” based on stocks’ historical lethargy as the summer begins and market participants go on vacation. While not foolproof, it has been true often enough to warrant attention. Stocks may have gotten ahead of themselves and could be due for a significant correction. One useful study is to compare the yield on stocks to that of bonds. A stock’s yield is simply the inverse of its price earnings ratio. According to FACTSET, as of May 10th the forward P/E of the S&P 500 is 20.4 times. A P/E of 20.4 gives an earnings yield of 4.9%. That is higher than the ten-year treasury yield’s 4.42%, the first time since the crash of 2000 that the earnings yield has topped the ten-year. An earnings yield higher than the bond yield is one sign of an overpriced market. It deserves mentioning that the 20.4 P/E is above the 5-year average (19.1) and above the 10-year average (17.8).

The run-up in stocks this month suggests a momentum-driven market. To measure momentum, market technicians may use the Relative Strength Index, a momentum oscillator that measures the speed and change of price movements. The RSI oscillates between zero and 100. Traditionally the RSI is considered overbought when above 70 and oversold when below 30. The Dow Jones Industrial, Standard and Poor’s 500, and NASDAQ Composite are all pushing up against the 70 level. (Unsurprising, given last week’s Weekly Market Update that discussed the weakness of small cap stocks, the Russell 2000 is not so overbought.) The indices may go even higher for a while, but there will be a correction.

Despite the euphoria that came out of the inflation report, inflation has merely cooled. Prices are still rising, even if at a slower rate. Things cost more than they used to and will cost still more next year. It does not mean that things are getting better, just that they are getting worse more slowly. Higher prices have required Americans to spend more of their savings to maintain their lifestyle. The national savings rate has declined to 3.2%, the lowest in 17 years. The consumer seems to have been “tapped out,” with the University of Michigan’s consumer sentiment index falling to a six-month low on inflation and unemployment fears. With a stock market correction becoming more likely, and with short-term bonds offering real yields (yields adjusted for inflation) of 2%, it makes sense for even the most aggressive investor to maintain a portfolio of short-term fixed income investments within their accounts.

Have a Wonderful Week,