I have been discussing the lack of a 1% move in the S&P 500 for a few weeks now. This streak finally ended Wednesday as it rose 1.37%. The next streak which is much more ominous is the 96-day streak without a 1% decline in the S&P 500. The idea of a 5% correction happening anytime soon seems impossible. The chart below shows the corrections since the start of the bull market. The market is currently in the longest stretch of this cycle without having a 5% fall. When this reverses, the crash will only be greater now that the market has overstretched itself beyond most investors’ imaginations. Bank of America raised its year end S&P 500 target from 2,300 to 2,450. The S&P 500 can easily meet 2,450 in March. It would be shocking to see an upgraded target for the whole year reached in the third month.

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In my last article, I mentioned the main reason for the large rally on Wednesday was Trump’s speech to Congress. While the speech was important, one other reason for the rally was the spectacular ISM Manufacturing PMI report. The PMI reached 57.7 which was above expectations for 56.2 and was the highest reading since December 2014. The New Orders Index hit 65.1% which was up 4.7% from last month and was the highest reading since December 2013. The chart below shows a breakdown of the components of the PMI. As you can see, most components are accelerating which is why this is an A plus report.

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This PMI reading is consistent with 4.5% GDP growth. January’s PMI was consistent with 4.0% GDP growth. If these surveys were accurate, GDP growth must be above 3.5% unless March falls off a cliff. The reality is Q1 GDP growth will not come close to 3.5% based on the current economic reports we’ve seen. The reason GDP won’t reach what the Manufacturing PMI is suggesting is because there was been a wide bifurcation between the survey data and the hard data. The chart below shows the Bloomberg surprise index for soft and hard data. The hard data is in the range it has been in this entire recovery, but the survey data is near cycle highs. The difference between the two is at cycle highs. Either the economy will have a great second half of 2017 or the surveys will start to weaken soon.

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Regardless of which direction the economy heads in, in the second half, the Q1 GDP will reflect what the hard data is showing, meaning it will be weak. As you can see from the chart below, the range of GDP estimates is from 2.0% to 2.6% with the average estimate at 2.2%. Goldman Sachs expects 1.8% growth, JP Morgan sees 1.5% growth, and Bank of America sees 1.3% growth. The Atlanta Fed GDP Now forecast is showing 1.8% growth. The Atlanta Fed model is usually not accurate at the beginning of the quarter and becomes more accurate as the data is released. This chart looks like the charts I’ve seen in the past few quarters. Below 2% growth would be consistent with the weakest recovery since 1949. It makes the rally in the stock market look silly.

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The auto sales data also was released on Wednesday. I have been focusing on this data because of the potential bubble brewing. The seasonally adjusted annual sales rate was 17.58 million which missed expectations for 17.7 million. There has been a shift in sales from cars to trucks and SUVs. Ford stated total industry volumes for cars in February were expected be 35% of the total which is down from 53% of volumes in 2010. This is great for the auto companies as they have higher profit margins on SUVs and trucks. As of Q4, 3.8% of auto loans were more than 90 days late. The increase in delinquencies may signal the cycle is about to weaken. However, I’m cautious about predicting that the auto market will roll over in the first half of the year because I was wrong about the credit cycle rolling over last year.

Lately there has been a lot of chatter about Warren Buffett’s optimism about the stock market. Because the bull market is driven by sentiment, Buffett’s words hold more importance than usual. It’s also always interesting to hear the perspective of an investor with many decades of experience given the historic nature of this rally. It is the second longest bull market in history and the third largest. The market has rallied 259% which means it’s closing in on the 2nd largest rally which was 267%.

Warren Buffett is bullish on the long-term future of the stock market because he has become an elder statesman. It doesn’t benefit him to be negative on stocks. However, if he was using his favorite valuation metric, he would say the market is in a massive bubble. As you can see in the chart below, the ratio of the market cap of the stock market to the gross national product of the economy is near the peak last seen in the late 1990s. The choice investors have is clear. If you buy stocks now, you are betting record profit margins will be achieved and President Trump’s agenda of tax cuts and deregulation will spur 3%-4% GDP growth. While I’m hopeful that deregulation will help long-run productivity, I’d rather stay out of stocks at these excessive valuations.

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Conclusion

It’s clear stocks are overvalued, but this caution would have made you miss a great start to the year as the S&P 500 is up 7% year to date. On the bright side, the ISM PMI Manufacturing report showed the highest rating in 3 years. On the negative side, the auto sales for February missed expectations. Q1 GDP is expected to be less than 2%. The Q1 economy isn’t a result of Trump’s policies. I will start to give Trump benefit/blame for the economy’s performance in the second half of 2018. I am bearish on stocks because even if the economy achieves the best-case scenario, long-run returns will likely be poor because of how expensive stocks are.