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3 Questions Investors Can Ask as Stocks Reach Record Highs

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August 23, 2016
Advice for investors looking to sell stocks and make profit.

Through August 15, the S&P 500 recorded ten new all-time highs since July 11. Not too shabby. This bull market in U.S. stocks has surmounted a wall of worry throughout 2016. Maybe investors should nickname this year’s market the "Comeback Kid." 

Never sell a dull market short. As the S&P 500 quietly climbs to all-time highs amid light volume and narrow ranges, JJ Kinahan, chief market strategist at TD Ameritrade, reminds investors of an old market adage: "never sell a dull market short." The conventional wisdom behind that old market saw spins on the idea that a quiet market is building energy for a big move. 

"The path of least resistance seems to be to the upside," Kinahan says. While traders are awaiting the "Speech of the Week" from Fed Chair Janet Yellen at the central banker's mountain meeting in Jackson Hole, Wyoming, the S&P 500 continued to trend higher. Let's take a look at current market dynamics. 

Potentially Bullish Factors for Stocks

What's behind the most recent rally in stocks? Kinahan points to the Fed's persistently low interest rates as a major factor keeping the wind in stock bull's sails. "Interest rate increases keep getting pushed out further on the horizon. Investors are looking for yield and that makes traditional stocks look more attractive," Kinahan says. Also, quite simply, "as we started to rally after Brexit, the shorts just ran out of gas, and short-covering helped lift the market," Kinahan adds. 

Potentially Bearish Factors for Stocks

Every coin has two sides and where there’s a bull case, there’s also a bear case. Here are 4 risks for the bull market in stocks right now.

1. The U.S. Presidential Election: "There are a lot of unknowns, which keeps people from wanting to commit to positions," says Kinahan. That can include both stock market investments and businesses sitting on the sidelines regarding new investments, spending, or even hiring.

2. Geopolitical Risks: "The world is a little unstable and it's difficult to predict what could happen," Kinahan says.

3. Sluggish Global Growth: Sure, the U.S. economy has been growing, but other global economies remain challenged. "The U.S. is helping to support a lot of other economies right now. It could slow U.S. stock momentum," Kinahan warns.

4. Stock Market Overvaluation: There's no getting around it. Stocks are expensive right now. The price/earnings ratio on trailing 12-month GAAP earnings per share stands at 25.3 currently, versus an average of 19.2, according to Sam Stovall, managing director at S&P Global Market Intelligence. The only time it was higher since WWII was in 2000 at 31.7. See figure 1 below.

FIGURE 1: GAAP PRICE/EARNINGS (P/E) RATIOS.

The GAAP P/E ratio current sits at 25.3. Image source: S&P Global Market Intelligence. Not a recommendation. For illustrative purposes only. Past performance does not guarantee future results.

3 Questions Investors Can Ask Now

With stocks at all-time highs, it might be a good time to review a portfolio, Kinahan says. 

1. Do you want to take some profits now? "With stocks near all-time highs, it’s not the worst idea to consider taking a little risk off the table," Kinahan says. 

2. What sectors could be net winners or net losers after the Presidential Election? Have an opinion on how the election could impact specific stock sectors? "If you're long some health care stocks and think they might be affected by the outcome, consider if it’s time to make a portfolio shift," Kinahan says. 

3. Consider the impact of a Fed rate hike on stocks and sectors. "The CME's Fedwatch tool shows a 41% probability of a Fed rate hike at the December meeting," Kinahan notes. When do you think the Fed will raise rates? If you think interest rates will go higher, consider what stocks could benefit. "For instance, historically this has been financials," Kinahan says. 

Last but not least, Stovall warns that while elevated valuations are a risk for the stock market, that doesn't necessarily mean it’s a good market timing tool. After all, "One of the defining characteristics of this market's first-half performance in 2016 has been its resiliency in the face of a very high wall of worry," Stovall concludes. 

Not sure which stocks belong to which sector? TD Ameritrade clients can use the Visualize tool to determine which sectors certain stocks belong to as seen in figure 2.

FIGURE 2: VISUALIZE STOCK MARKET SECTORS.

Log in to the thinkorswim platform and click Marketwatch > Visualize to access this tool. Image source: the thinkorswim® platform by TD Ameritrade. Not a recommendation. For illustrative purposes only. Past performance does not guarantee future results.