Pendulum swung too far

Traditionally, equity people are supposed to be more optimistic than bond people, but I am prepared to buck the stereotype. I am not about to argue we stand on the brink of savage correction, but it is fair to say that I am a little circumspect.

The market pendulum tends to swing too far in both directions. Does the simple recognition the world is not about to end explain why the S&P went up more than 15% in 10 weeks? At 17.5x forward earnings, stocks will not look particularly cheap should Q1 run-rate earnings come in at about $100 per share, as seems likely. It is a long way from the $120 we feel is required to support today’s multiples. For sure, dollar strength has eased – but this was already underway by H2 2015. Energy may be less of a drag – but does it mean we will see breakout numbers from the financial, industrial, or consumer sectors? The big value sectors hit hard during the New Year sell-off – energy, materials and industrials – are up 6-8% YTD, but the other big performers are defensive consumer staples and utilities.

I believe this is a 'relief rally' lacking a degree of conviction and is really a response to the excessive New Year pessimism. Again, we are not talking about extremes in valuations. But the pendulum has swung far enough I do not feel compelled to chase this market. I need to see much firmer evidence of an earnings revival over the coming seasons to change my mind.