Is the S&P 500 Poised For A Drop?

Having noted the market’s positive move earlier today, perhaps it’s time for a bit of caution:

FactSet, Barclays Research

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That’s from Barclays Equity Research analyst Barry Knapp, who notes that the last few times the Standard & Poor’s 500 index has hit a forward price-to-earnings ratio over 13, it’s almost immediately seen a drop. As Knapp writes:

In each of these instances, the reality of 2% trend growth squashed hopes of achieving economic escape velocity, and investors turned their attention back to fixed income markets, as well as the parts of the equity market with bond-like characteristics.

Knapp goes on to suggest that the recent richer market multiples are thanks more to China’s recovery than the rebound in US housing, particularly “given that the two sectors most closely associated with Asia � materials and industrials � look the most stretched relative to those prior peaks. Energy has also had a strong recent recovery.”

And, ending on even more of a downbeat note, Knapp outlines why he thinks the market may be due a drop:

Additionally, it is looking increasingly likely that the sequestration spending cuts will be allowed to go into effect in March. It appears to us that the $200bn in fiscal tightening, predominately tax hikes, is imbedded in private economist forecasts, but the sequestration-related cuts are not. Further, based on the experience in Europe in 2012, the risk is that fiscal multipliers will prove larger than estimated. Given equity market earnings forecasts and valuations, we think equity investors are considerably more optimistic than economists and may be positioned for disappointment as the economic outlook slips back towards trend, despite a world awash in central bank liquidity.

It seems odd, after all the bearish sentiment, to read that investors “may be positioned for disappointment” but the evidence of flows into stock funds suggest many have come back possibly too late.