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Wall Street experts warn that the stock market's red-hot rally could be in jeopardy.
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Recession risks remain and excessive inflation could pose a headwind.
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Meanwhile, valuations are high, thanks in large part to the AI madness that is still sweeping Wall Street.
The stock market's red-hot rally poses a host of risks that could derail the stellar performance of the last four months.
Wall Street experts are sounding the alarm that stocks are overvalued and the economy remains in a precarious position – even as some investors remain confident there will be a soft landing.
But the danger of a recession certainly exists, even if the economy appears resilient on the surface. The bond market has been sounding recession alarms since late 2022, with the infamous 2-10 Treasury yield curve briefly reflecting its steepest inversion since 1981.
The “full model,” another recession indicator based on a handful of economic data points, shows an 85 percent probability that the economy could be hit by a downturn this year, the highest probability of a recession since the Great Financial Crisis.
According to Paul Dietrich, chief investment strategist at B. Riley Wealth Management, even a mild recession could cause the S&P 500 to fall by more than a third. He pointed to the recession that hit the economy in the early 2000s, when GDP fell just 1%, although the S&P 500 fell by almost half as the bubble in Internet stocks burst.
“Even in a mild recession, investors who hold the S&P 500 index should expect to lose over a third of their retirement investments in stocks,” Dietrich wrote in a note last week.
Inflation has also disappointed economists, another factor that could help stocks fall from their highs. Consumer prices were higher than expected in January, rising 3.1% year-on-year. Core inflation rose 3.9%, the strongest increase in eight months.
Higher prices have dampened prospects for Fed rate cuts this year, which central bankers will consider only if they are confident inflation will return to its 2% target.
The story goes on
This means investors are likely to be disappointed by the size and timing of interest rate cuts, which could deal a major blow to stock markets. Markets are still pricing in a 32 percent chance that interest rates could be cut by 100 basis points by year-end, more than the Fed's official forecast, according to the CME FedWatch tool.
“The real problem – and one that most people hadn't even begun to think about – is that if inflation picks up and rises again, the Fed will be forced to raise interest rates again, which would have a significant impact on stock prices .” “Chris Zaccarelli, CIO of the Independent Advisor Alliance, wrote in a note this week.
It doesn't help that stocks keep hitting new highs and the S&P 500 closed at another record on Thursday. Investors are in a frenzy over artificial intelligence, which has catapulted shares of the Magnificent Seven to dizzying heights over the last year.
But the market is likely driven mostly by investor hype, Dietrich said, meaning many stocks are likely overvalued.
“So many investors get caught up in the excitement, momentum and enthusiasm of a stock market that runs like the Kentucky Derby,” Dietrich said in a note last week. “It's this irrational fear of missing out, or 'FOMO,' that drives this behavior.”
The Magnificent Seven reflects one of the biggest “speculative orgies” the market has seen in decades, investing veteran Bill Smead told Business Insider in December. Smead said he expects the most expensive stocks on the market to eventually wipe out 70% of their value.
John Hussman, the Wall Street investor who predicted the market downturns in 2000 and 2008, also warned that stock prices could plummet as valuations appear extreme.
“Without making any predictions, it is fair to say that we would not be surprised by a short-term market loss of the order of 10% or more in the S&P 500, nor a full-cycle market loss of this magnitude.” to 50-65%, nor a U.S. recession, which the consensus appears to rule out,” he said in a note this month.
These risks could be lost on some investors who are fairly optimistic that momentum in stocks can continue. According to AAII's latest Investor Sentiment Survey, 42% of investors said they are optimistic about the stock market over the next six months.
According to a Yale School of Management survey, 81% of individual investors expect the Dow to end the year higher. The most optimistic investors have been since March 2007.
Read the original article on Business Insider
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