Did the Market Just Hit Its Peak for the Year?

Did the Market Just Hit Its Peak for the Year?

U.S. stocks are roughly unchanged this morning, with the S&P 500 and the narrower, price-weighted Dow Jones Industrial Average up 0.4% and 0.46%, respectively, as of 10:10 a.m. EDT.

Top that!
Yesterday, hedge fund manager-cum-hyperactive financial diarist Doug Kass -- his contract with TheStreet requires that he "post market commentary and trading ideas twelve times each business day to his daily diary on Real Money Pro" [emphasis mine] -- made a grave pronouncement on CNBC: "The market could be making a high for the year this week and possible even longer. I'm flat-out saying the market is making a top here."

That has a familiar ring to it -- maybe because on Jan. 29 of this year, Kass told CNBC: "The market probably has a fair value 80 or 90 S&P 500 points lower than where it is now, so that would imply a decline of 6% or 7%, but I think the more important statement I'm making is that we are likely to be in the process of making a yearly high for the year."

Roughly three weeks earlier, on Jan. 9, Kass had already written: "I believe that the U.S. stock market will make its 2013 high in the first two weeks of January, be in a yearlong range of 1275-1480 and close the year at 1425."

Since Jan. 29, the S&P 500 has risen 11.5%.

I don't fault Mr. Kass for being wrong -- that happens all the time in the punditry business. I fault him for not recognizing that market timing is a loser's game. That's the difference between making a gameplay error and choosing the wrong contest to begin with.

Perhaps Kass believes the repeated new highs the market has made this year are a sign of impending doom. That need not be the case, as the brilliant Anatole Kaletsky explained in mid-March, with the S&P 500 on the verge of breaking its October 2007 high:

Bearish analysts often claim that stock market peaks have always been followed by sharp falls, citing as evidence the record high of October 2007, which was quickly followed by a 57 percent collapse in 2008-09. ... These precedents, along with the even more vertiginous peaks of 1989 in Japan and 1929 on Wall Street, certainly sound scary, but they are meaningless.

It may be true that all major market peaks have been followed by big declines, but the reason is semantics, not finance or economics. A peak is, by definition, a high point followed by a decline. A new market high that is not followed by a fall in prices is simply not called a peak. A record of this kind, far from preceding a steep decline, tends to act as a staging post for higher prices. Looking back through history, it turns out that this benign type of record, paving the way for higher prices, is actually the norm.

Since making a new all-time high on March 27, the S& 500 has risen 7%. That may make some investors and pundits nervous, but there is little to fear with regard to new highs per se: Stock prices do not mean-revert -- i.e., rather than fluctuating around an average, stock prices tend to drift upwards over time.

Stock valuations, on the other hand, are an entirely different matter. Price-to-earnings ratios, including the cyclically adjusted price-to-earnings ratio, or CAPE, certainly do revert to the mean. How is the market doing on that front?

As of yesterday's close, the CAPE, which is based on average inflation-adjusted earnings over the trailing 10-year period, stands at 23.8, substantially above its long-term historical average. That's a legitimate cause for concern; it doesn't mean stock prices must fall tomorrow, next week, or next month, but history suggests that such a multiple is unsustainable and that some sort of adjustment is likely.

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The article Did the Market Just Hit Its Peak for the Year? originally appeared on Fool.com.

Fool contributor Alex Dumortier, CFA has no position in any stocks mentioned.; you can follow him on LinkedIn The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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