Watching The Stock Market With Skepticism

market caution:  A few days back, I got a call from my aunt, whom I haven’t spoken to in a while. It was shocking to me—no, not her calling, but rather what she asked me. Before I go into any detail, here’s some background information: as an investor, my aunt has a little experience with the stock market, but gave up because it didn’t suit her low risk tolerance.

“I have been saving money for some time now; it’s been sitting in my bank account and earning next to nothing,” she said to me. She heard on the news that the stock market in the U.S. is going higher and that the S&P 500 has reached its all-time high—she wanted to know what I thought she should buy. “I think it’s about time I take some risk,” she added.

My aunt hasn’t bought stocks in a while; in fact, she has missed out on all the gains made since the stock markets bottomed in 2009.

What does this tell me?

I find this a little scary, as should anyone who has been following the stock markets for a while. What my aunt said makes me skeptical; it shows that the notion of missing out is emerging. In the past, we have seen the stock markets reach their all-time highs, which gave investors the feeling they were missing out on gains. They bought, the key stock indices increased a little, and then the sell-off occurred; they got caught in it and lost a significant amount of their portfolio. Historically speaking, there are many examples of this.

As this is happening, I see the fundamentals deteriorating.

To assess the stock market’s health, one factor I look at is the “surprise rate” of corporate earnings—namely, how much better profits are compared to analysts’ estimates. The higher the surprise rate, the better the move in the stock market is going to be.

Unfortunately, for the past few quarters, the surprise rate of corporate earnings has not been impressive at all. For example, in the third quarter of this year, the earnings surprise rate for S&P 500 companies was 1.7%. Over the last four years, this rate averages out to be 6.5%. If the corporate earnings surprise rate of the S&P 500 companies in the fourth quarter remains the same, then it would be the lowest since the fourth quarter of 2008. (Source: “Earnings Insight,” FactSet web site, November 29, 2013.)

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