Stocks rallied sharply for the second consecutive week last week. Two back-to-back weekly gains of more than 4 percent are relatively rare occurrences—only 13 times since 1918. Unfortunately, it’s difficult to glean much from such an event.
There’s an old adage on Wall Street that “strength begets strength;” that a powerful move by stocks is indicative of more good things to come. And indeed, looking at more than 90 years shows this has often been the case. Prior to this decade at least, two up weeks like we’ve just come off of typically resulted in blue chip stocks advancing further in short order—often by double-digit margins. During the past decade, however, the outcome has been less clear-cut. In some cases stocks moved higher for a little while, but in all cases the market soon faltered and was lower in the following 13 weeks. In 2000, one of these back-to-back weeks occurred right at the market top. As you know, share prices went on to lose nearly half their value.
Today’s situation is more like those of recent vintage than earlier occurrences in that the stock market's valuations are stretched right now. Unlike, say, December 1987, when the average stock sported a P/E of 12 and a dividend yield of more than 3 percent, today the S&P Industrials’ P/E stands at nearly 28 (on a trailing basis) and it yields just 2.2 percent.
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