With a market bounce under way, here's the next big hurdle for stocks

Published Thu, Aug 11 20229:30 AM EDTUpdated Thu, Aug 11 202210:20 AM EDT

The next hurdle for stocks: Can the market handle a higher multiple? The S & P 500 is up 14.8% since the June 16 low. The Cboe Volatility Index (VIX) is trading below 20, near its lowest levels since early April. Does the melt-up continue as risk melts away? The market is now broadening out: The NYSE advance-decline line is in its most significant upswing since early March, as retailers and banks join technology stocks in the rally. More than 80% of stocks in the S & P 500 are also above their 50-day moving average, according to BTIG. Retail investors are certainly more bullish than a couple months ago. The American Association of Individual Investors sentiment indicator is pushing into bullish territory, with a third of investors now saying they are bullish, the highest bullish levels since March: AAII Sentiment Indicators (stock market in next 6 months) Bullish: 32.2% Bearish: 38.9% Neutral: 30.6% The big issue for stocks will now be valuations: The market is again getting expensive. While earnings have remained fairly stable for the S & P 500, the P/E ratio (multiple) — which is what investors are willing to pay for a future stream of dividend and earnings — has been all over the map this year. It started the year at a little over 21, then dropped to roughly 16 at the low in June, close to its historical average. The forward earnings multiple for the S & P 500 is now at 18 and rising fast. "We still like stocks but worry the current rally is overdone," Nicholas Colas from DataTrek said in a note to clients Wednesday night. "Happy as we are that stocks read the CPI report as proof that inflation is heading in the right direction, we wonder if the current rally off the June 16th lows is perhaps a bit too euphoric." But bulls argue that a recent slate of positive macro developments (consumer strong, moderating inflation) means there is less earnings risk, thus allowing for a higher valuation. They argue that the case for a recession, already perceived to be "mild," has only receded further. Unemployment is too low for a recession, and the other major risk for recession — that the Fed was going to over-hike — is starting to recede as well. For the moment, bulls are enjoying the breakout. "Historically thrusts like this tend to suggest continued strength," BTIG said.

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