Crisis Threat Gains Influence Over U.S. Stock Volatility: Chart of the Day

“Crisis mentality” has become so widespread that swings in U.S. stocks are attributable mainly to the level of investor concern, according to James W. Paulsen, chief investment strategist at Wells Capital Management.

The CHART OF THE DAY tracks the relationship between changes in the Standard & Poor’s 500 Index and the Bloomberg U.S. Financial Conditions Index, a gauge derived from values in the money, bond and equity markets. The data are based on daily moves during the preceding 12 months.

The so-called coefficient of determination climbed two days ago to 0.79, the highest in the 17 years of history available for Bloomberg’s index. This meant that the financial-conditions index’s gains and losses would explain 79 percent of the S&P 500’s performance.

“This intense crisis focus leaves little room for investors to base stock valuations on fundamentals,” such as earnings and sales, Paulsen, who is based in Minneapolis, wrote two days ago in a report that included a similar chart. That explains why the S&P 500 isn’t trading at a higher multiple of earnings, he added.

Yesterday’s close for the index equaled 12.2 times this year’s projected earnings for the S&P 500, according to data compiled by Bloomberg. A ratio of 16 times earnings would be more in line with yields on 10-year Treasury notes and profit growth for companies in the stock index, according to Paulsen.

“As the culture slowly turns away from an imminent expectation of crisis and focuses again more on fundamentals, the valuations applied to the stock market should rise substantially,” he wrote.

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