You have probably enjoyed a cappuccino or latte at least once or twice in your life. The delicious froth on top of the coffee base is made by whipping milk at a very high temperature and at great speed. My guess is that you drink your latte before the froth dissipates – but if you were to let it sit for a few minutes, all you would have is a simple cup of coffee with milk. If you translate it to the markets, you could ask whether the markets are getting frothy, and if so, will the froth dissipate, leading to a sell-off?
In mid-October, we finally got closure (but once again, no solution) to the budget deficit and the debt ceiling discussions, with all being deferred to a later date. This deferral, however, provided the markets with enough short-term certainty to stage a solid advance for the month, with the S&P 500 up 4.5%.
The S&P 500 is now up 23.2% for the year, with the majority of these gains coming in the first half of the year. Such magnitude hasn't been seen since 1997, which raises the question as to whether profit-taking is in order, or will momentum carry the market higher?
Historically, momentum has won the debate handily. The chart below illustrates this point, highlighting years where the S&P 500 has advanced more than 20% through October, yet continued to push higher through year-end.
That being said, we do think there is quite a bit of froth in the market. Investor sentiment is currently very high, which seems like a good thing, but actually argues for a short-term pull-back. We believe any pull-back will be a buying opportunity, with momentum carrying the market higher into year-end.
With that said, we are concerned about what is in store for the markets in 2014. While we believe we may have moved into a long-term (“secular”), 2014 may present investors with some challenges. We will touch on this in next month’s newsletter. In the meantime, enjoy the autumn, and the upcoming Thanksgiving holiday!
Live well. Invest well.
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