Even if US equities aren’t in a bubble, a correction might be on the horizon.
Even if it is still not apparent if stocks are in a bubble or a robust bull run, some market participants think the relentless U.S. stock rally is about to take a break.
Over the past five months, the benchmark S&P 500 (.SPX) index has increased by more than 25%, an occurrence that has happened just ten times since the 1930s, according to BofA Global Research. With Nvidia’s meteoric rise in the forefront, the S&P 500 has set 16 quarterly records, the most since 1945, according to CFRA. (opens new tab)
Those who are bullish on the market say the gains are based on strong fundamentals, not the kind of wild speculation that has accompanied previous booms. Some of the most common explanations are the optimism surrounding AI’s commercial potential, the widespread belief that the Federal Reserve would lower interest rates this year, and the robust state of the American economy.
However, there are some who think a reversal is in order because the market has climbed almost continuously. While such sell-offs typically occur three times each year on average, the last time the S&P 500 plummeted more than 5% was in October, according to BofA data. The index has gained 8.5% so far in 2018.
Michael Arone, chief investment strategist at State Street Global Advisors, stated that the market has already priced in a lot of positive news. In my view, it only goes to show that the odds are against us.
What might trigger a market sell-off is unclear at this time. The extent to which the Federal Reserve will reduce rates this year has been dampened by stronger-than-expected inflation, although many still anticipate that borrowing costs will continue to fall. Rising consumer prices have been interpreted as a sign of robust economic health.
Despite worries about China’s weak economy and certain unstable regions of U.S. regional banks, investors have mostly ignored these issues. However, a few warning signs are appearing. According to statistics compiled by Miller Tabak, the weekly relative strength index (RSI) of the S&P 500 has risen to slightly over 76, a level it has seldom above since the year 2000. This measure determines whether stocks are overbought or oversold. Whenever the index surpassed specified thresholds, substantial sell-offs ensued. For example, the S&P 500 fell 10% in January 2018 and 30% in January 2020 following the emergence of COVID-19.
According to Miller Tabak’s chief market strategist, Matt Maley, none of this points to a significant long-term peak. The fact remains, though, that this indicates a major pullback is imminent.
Anxieties among investors has been on the rise recently. In the most recent weekly survey from the American Association of Individual Investors, the percentage of investors expressing a positive outlook for the next six months of stock prices jumped to 51.7%. This is only the fourth occasion in nearly three years that this percentage has surpassed 50%. Since a high level of optimism indicates that the threshold for pleasant surprises is raised, it is frequently seen as a contrarian indication. According to Kevin Gordon, senior investment strategist at Charles Schwab, the market is susceptible to a downward move given the current emotional backdrop.
The present surge might be ready for a break, according to past events. With its record high on January 19 and subsequent 7% gain, the S&P 500 recovered all of its losses from the previous bad market.
In previous rallies, when stock prices continued to rise after reaching new highs, such was the case. The chief investment strategist at CFRA, Sam Stovall, noted that the 12 times this happened, the market fell by at least 5% after the corresponding moves.
Some have drawn parallels between the current market optimism and previous eras when asset prices reached unsustainable heights before tumbling, such as the meme stock rallies of 2021 and the dot-com surge of 1999. This is in response to the skyrocketing share prices of Nvidia and other AI-focused companies. After trebling in 2023, Nvidia’s stock has increased by more than 80% this year, propelling it to the position of third most valuable U.S. corporation. Super Micro Computer (SMC), which is associated with artificial intelligence, has increased by 300 percent and is about to be added to the S&P 500. Other AI-related equities have also experienced remarkable gains so far this year.
Strategists from JPMorgan said that Nvidia has a good correlation with the performance of the S&P 500.
The experts warned investors that this correlation will most likely turn around once the excitement surrounding artificial intelligence reaches its height. But some people see parallels to previous bubbles and others don’t. According to Truist co-chief investment officer Keith Lerner, the technology sector of the S&P 500 has outperformed the broader S&P 500 by around 30% over the past three years. According to Lerner, that is significantly lower than the peak of slightly more than 250% in March of 2000 and is in line with the 30-year norm.
The new issue market, which has seen relatively few initial public offerings, also does not appear to be in a state of ecstasy.
Nicholas Colas, co-founder of DataTrek Research, stated that only 54 firms had initial public offerings (IPOs) in 2023, down from 311 in 2021, prior to the S&P 500 reaching its peak in January 2022. Savita Subramanian, an equity and quant analyst at BofA Global Research, noted that while sentiment has warmed up on stocks since mid-2023, it is still far from the positive levels of previous market peaks. Just recently, the bank increased their S&P 500 year-end target from 5,100 to 5,400. The index ended Tuesday’s trading session at 5,175.27.
According to her, this bull market could continue for some time.
