Bringing out the bubbles is a good idea if you want to entertain a toddler, but not so much if you want to make money. There are no signs of giving up on this exchange yet.
You wouldn't know it with all the hand-wringing. Google searches for the term “stock bubble” are at their highest level since January 2022, and judging by my inbox, strategists are fielding questions from concerned clients about how shaken the stock market is. All this if the
S&P 500
The index just ended the week up 0.9%. It was enough to push Bridgewater Associates founder Ray Dalio into the fray with a nearly 1,700-word missive about why the market isn't in a bubble.
Of course, there is more to the dismay than just a week. The S&P 500 just closed the first two months of 2024 with a gain of 6.87%, its best start to the year since 2019. And that
Nasdaq Composite,
For its part, it closed the month at its first record high since November 2021. Valuations are also high by historical standards, at 20.6 times 12-month forward earnings. Torsten Sløk, chief economist at Apollo Global Management, notes that the median price-to-earnings ratio of the ten largest stocks in the S&P 500 is higher than it was in 2020, 2010 and even at the height of the dot-com bubble in 2000, when it was about 25 times as high.
And there's more to worry about than just big wins and bad reviews. Disinflation is slowing. The Federal Reserve will not make the seven interest rate cuts that markets expected at the start of the year. In places such as E.g. signs of foam can definitely be seen
Bitcoin,
which is up 23% in the last seven days and is just 6.4% below its record high, as well as individual stocks like Super Micro Computer
,
that have taken the hype around artificial intelligence to astronomical heights.
Even the concentration of market gains in a handful of stocks – the Magnificent Seven – is seen as a cause for concern about the sustainability of the rally.
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It's time to stop worrying. On the one hand, the economy continues to hold up far better than anyone expected. Gross domestic product was revised slightly downward in the fourth quarter, from 3.3% to 3.2%, but remains strong. This strength is expected to continue into 2024, with the Atlanta Fed's GDPNow model pointing to 3% growth in the first quarter of the year. Inflation remains stronger than the Fed would like, but January's consumer spending price index “was an inflation data point that was not obviously hawkish,” writes Dennis DeBusschere, founder of 22V Research.
However, investors are still expecting this strength to end. Savita Subramanian, head of U.S. equity and quantitative strategy at BofA Securities, notes that while Wall Street strategists are generally more bullish than bearish, fund managers still have a bleak view of the world.
Long-only mutual funds have hedged their downside risk by keeping their exposure to economically sensitive stocks relative to defensive stocks near their lowest levels since the 2008-2009 financial crisis, she writes. Hedge funds, on the other hand, protect themselves from a market downturn by maintaining their “betas,” or exposure relative to the market, at similar levels. They are also underweight stocks that would benefit from higher inflation and good economic news.
“[They’re] hedged against anything but positive tail risks,” writes Subramanian.
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Even market concentration doesn't seem to pose as much of a risk as it seems. John Kolovos, chief technical markets strategist at Macro Risk Advisors, points out that the S&P 500 as a whole, rather than the average stock in the index, has been the big winner for investors over time.
Since 1998, for example, the S&P 500 is up 300%, while the Value Line Geometric Index, which it describes as a proxy for the average stock, is up just 17%. He attributes this outperformance to the fact that, although the S&P 500 is an index, it is more like an actively managed fund with a momentum bias – the winners get bigger and the losers get left behind.
“While analysts like me are right to say that participation or breadth could be better, when it comes to actually making money, we have to follow history,” writes Kolovos. “Do you want to be right or do you want to make money?”
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Instead of expecting the worst, investors should simply accept that, at least historically, the bull market that began in October 2022 is only half over. According to Pat Tschosik, senior portfolio strategist at Ned Davis Research, the average bull market since 1930 has lasted 694 days. The current date is only 344 days old, meaning it's only about halfway through.
That means it might be time to follow the mid-cycle playbook, according to Nicholas Colas, co-founder of DataTrek Research. Mid-cycle is the period between the first phase of emerging from a recession and the late cycle when the economy is heading towards a downturn.
Mid-cycle markets aren't easy – they're, as Colas describes it, kind of boring. Volatility is low – the Cboe Volatility Index (VIX) of 13.27 certainly meets this criteria – and returns are generally solid and sometimes even better. “Of course, this doesn’t stop the bears from warning of an impending catastrophe,” Colas writes. “After all, that’s what they do, even if they’ve been wrong for years.”
So stop calling it a bubble – it’s just an ordinary bull market.
Write to Ben Levisohn at [email protected]
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