At the start of the historically weakest month for equities there are plenty of reasons to believe stocks may be just about reaching a top - at least in the short term. The S&P 500 has surged 14 percent this year and is at its highest level in more than 4 years. Not counting 2009 when equities rebounded from their crisis lows, this could be the best year for stocks since 2003 - nearly a decade.
A report showing hiring in the United States in August was again much slower than expected and warnings of a slowdown at Intel and FedEx this week, which will likely foreshadow a very weak earnings season, have not been enough to deter investors buoyed by aggressive central bank action.
After the European Central Bank's pledge to buy the debt of troubled eurozone countries this week the Fed is widely expected to introduce new stimulus measure in the form of more bond buying when it closes its two-day meeting on Thursday. "Good news in good news and bad news is good news, largely because of the Bernanke put," said Eric Kuby, chief investment officer, North Star Investment Management in Chicago.
The S&P 500 is now trading at 13.3 time its forward earnings estimates, meaning investors are willing to pay just over $13 for a dollar of expected earnings from S&P 500 companies. Although that is below a median forward price-to-earnings ratio of 13.7 since 1976 - according to Morgan Stanley - it is close to the upper end of the range in the low-growth post crisis era of the last 5 years. During that time there has been a median price-to-earnings ratio of 12.9, according to Thomson Reuters data.
In fact, the recent price-to-earnings high was 13.5 in February 2011, just above current levels. If you are of the view that little has changed since then, there is no reason for the ratio to go much higher. That combined with a slowing earnings picture inevitably means lower prices.
"Our view is that the next double digit move in the market is down not up," said Morgan Stanley in a research note. The analysts, led by equity strategist Adam Parker, believe the S&P 500 will finish the year at 1,214, 15 percent below where it is now.
At current levels the risk-reward skew is starting to look less attractive then it did. That is especially true given the uncertainty the November presidential elections are likely to generate, as well as the potential for more slip-ups in Europe.
"We put a 1,450 target on the S&P for year and so I'm encouraged," said Jack Ablin, chief investment officer at Harris Private Bank in Chicago. "But I will say, if this trend continues, I'm inclined to declare victory and move to the sidelines (and) start taking profits."
The average analyst estimate for the S&P 500 this year is 1,383 according to a Reuters poll from the middle of the year. That shows Ablin is not alone. The S&P's performance has already outstripped most expectations. Another negative factor is the rapidly declining earnings outlook for the remainder of the year, as well as for 2013. Analysts are now expecting a 2.1 percent drop in third quarter earnings year-on-year. About a year ago they were looking for growth of nearly 15 percent.
This week Jonathan Golub, UBS's chief US equity strategist, cut his S&P 500 earnings outlook due to a weaker US economic outlook, conversion distortions from a stronger dollar, as well as weaker oil prices.
For 2012 Golub cut his S&P earnings forecast to $102.50 from $103.50 and to $107.00 from $110 for next year. Golub believes third quarter earnings will be just $25.10, 2 percent below the same period last year. On an annualised basis that would translate into an S&P 500 level of just over 1,300 given a price-to-earnings ratio of 13.
Signs are that those forecasts are already starting to come true. On Tuesday, FedEx Corp, the world's second-largest package delivery company, cut its profit outlook for the current quarter, saying weakness in the global economy was hurting demand for overnight international shipments. Three days later, Intel Corp cut its third-quarter revenue estimate due to a decline in demand for its chips, as customers reduce inventories and businesses buy fewer personal computers. A revision of Intel targets had been expected by some analysts after PC makers Hewlett Packard Co and Dell Inc warned of slow demand last month.
Golub is now talking about an earnings "drought" and even an earnings "recession."
"While investors are focused on monetary policy, we believe these weak earnings results will contain a market advance," he said in a research note. Golub has a year end S&P target level of 1,375, 4.3 percent below Friday's closing level.
The latest leg of the rally was a 2 percent surge on Thursday that pushed the S&P 500 to its highest in more than four years and the Nasdaq to its highest in 12 years.