3 Reasons Why I'm Worried About The Stock Market

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Includes: DIA, QQQ, SPY
by: Vahan Janjigian, CFA

Since bottoming out on February 11, the S&P 500 has surged about 15%, which has me more than a little worried. I'm worried that the market has run up too far too fast for no reason other than a Federal Reserve that seems to be determined to sit on its hands for at least a little while longer.

Fortunately, I took advantage of the selloff earlier this year to increase exposure to U.S. equities in most of my accounts and I have taken very little off the table. As a result, I'm holding less cash than I usually do. Yet, for a number of reasons, I'm getting concerned that the rally can't go on for much longer.

First, this is a presidential election year. That always brings with it an increased level of uncertainty. But this presidential year seems to have a higher degree of uncertainty than usual. Neither party has settled on a candidate… and the leading candidates in both parties have unusually high unfavorability ratings. I'm surprised that investors seem to be so complacent about the election. Keep in mind that stocks tend to underperform during presidential election years, especially when there is a two-term president in office.

Second, there is a real possibility that the British will leave the European Union. They joined the EU, but they never joined the eurozone. That's because they insisted on keeping control of their own currency. Leaving the EU may be less complicated for the Brits than it would be for other EU members who are also part of the eurozone, yet Britain's exit could be disruptive nonetheless for global economies. Those favoring "Brexit" want the country to control its borders as well as its currency. The referendum, scheduled for June 23, will be much closer than many pundits were predicting just a few months ago. A very recent poll conducted by the Financial Times indicates that 44% want to stay in the EU and 42% want to leave.

Third, stocks seem pricey. Based on trailing earnings, the price-earnings ratio of the S&P 500 is about 24.4. The long-term average is closer to 15. The price-sales ratio is also well above average. Of course, none of this suggests that a selloff is imminent. Price multiples have been higher in the past. You shouldn't worry about this if you expect sales and earnings to surge in the very near future. That's not something I expect, so I'll worry.

So why are stocks going up? As usual, I have to credit the Federal Reserve. I think investors are simply betting that the Fed will remain on hold, refraining from increasing interest rates any time soon. However, I believe the probability of one rate increase later this year is near certainty. I even think there is close to a 50% probability that we'll see two rate increases this year. Finally, I'd like to point out that we're already in the second half of April, which means that May is just around the corner. I'm sure you know what they say about May. Something about it being a good time to sell and go away?