The rally in US stock markets that marked the first half of 2023 is continuing into the second half, with optimistic investors holding on to the optimism that has helped the tech-heavy Nasdaq 100 index soar 42% year-to-date, while the bears are attempting to pinpoint the moment when momentum wanes and the trend shifts to the downside.
The dichotomy between the so-called stock market bulls – who are optimistic and buy stocks hoping that stock prices will rise – and the bears – who believe the market is on a downtrend and might try to profit from a fall in stocks – has increasingly wide.
“[It’s] It’s almost like a political landscape where each side looked at the other with anger and resentment, unable to find common ground,” said Liz Young, SoFi’s head of investment strategy, in a statement Thursday. “Understandably, given the plethora of conflicting data — not least the unexpectedly feverish stock market rally amid leading economic indicators and bond market signals clearly waving a red flag.”
US stocks continued to rally this week after encouraging inflation readings raised the likelihood that an end to Federal Reserve rate hikes could be in sight, while the likelihood of a soft landing with inflation back close to the 2% target the central bank returns, a recession rises, improve.
The S&P 500
SPX
broke above 4,500 on Thursday for the first time since April 2022 while also making a fresh 15-month high. Over the week, it is up 2.4% during the Nasdaq Composite
COMP
is up 3.2% and the Dow Jones Industrial Average
DJIA
is up 2.3% according to FactSet data.
See: Inflation in the US has cooled off significantly. Great. Here’s what’s not great.
Market analysts told MarketWatch that the bulls-bears debate will not end and sentiment will not turn “fully bullish” until uncertainties surrounding monetary policy, economic indicators and the inversion of the government bond yield curve are resolved.
“We are still in a monetary tightening cycle that may or may not be complete. “We have leading indicators for the economy that are pointing to a slowdown — there are many different signals, including yield curve inversions, that still suggest we’re not out of the woods,” Young said in a follow-up interview on Friday. “The debate will continue and I’m rather cautious here, especially given valuations at this level.”
“That means markets are likely to take two steps forward and one step back for now, unless there’s an event that negatively impacts investor sentiment again, like it did almost last year,” said Melissa Brown, managing director of applied Research at Qontigo.
The rise in the valuation of megacap technology stocks, including Nvidia Corp.
NVDA
,
metaplatforms
META
,
alphabet inc
GOOGL
,
has pushed the S&P 500 up more than 17% so far this year as optimism around artificial intelligence (AI) mounts. However, there is a risk that investors will pay an “inflated valuation” for a stock based on AI enthusiasm, but if they don’t get the “satisfaction” from it over the next 12 months, the valuation may no longer look attractive. he said young.
“When you buy stocks, you typically buy them based on a 12-month earnings forecast, and while AI may well be a completely transformative theme that’s rippling across various industries, it probably won’t change that.” [technology landscape] fully by the end of this year,” she said. “So what could go wrong is the time expectation.”
See: Nasdaq is making a big change to its most popular index. Here’s how this could affect your portfolio.
Qontigo’s Brown also pointed to recent stock market volatility, which has eased significantly since late March, when worries about the banking sector eased following the sudden collapse of Silicon Valley Bank. The CBOE Volatility Index
IX
was 13.31 on Friday, after last falling to its lowest level in more than three years. In general, a VIX reading below 20 indicates a perceived low-risk environment, while a reading above 20 indicates a period of higher volatility.
However, Brown said her models show that there is a widening gap between a fundamental model – which analyzes market volatility based on macroeconomic conditions – and a statistical model – which uses the data to identify where the volatility is.
“The statistical model predicts a much higher risk than the basic model and this is the first time this has happened in at least six years and probably longer. So that tells us that volatility is lurking somewhere… it’s simmering beneath the surface,” Brown told MarketWatch by phone on Friday.
The looming lack of liquidity is another major concern as investors are currently “significantly overbought” relative to liquidity, particularly in megacap growth stocks, said Raheel Siddiqui, senior research analyst for global equity analysis at Neuberger Berman.
Siddiqui, in his outlook for the third quarter stock market, said investor euphoria tends to wane as liquidity dries up, which is likely to happen soon on what could be a historic pullback in the coming weeks. He referred to the Fed’s plan to shrink its balance sheet each month, also known as quantitative tightening, the Treasury’s issuance of new debt to replenish the Treasury’s overall account after Congress raised the debt ceiling, and to the European Central Bank’s plan to withdraw €477 billion in TLTRO funding from the banking system.
See: ‘Significant liquidity squeeze’ threatens stock market once debt ceiling deal is finalized
“In our view, this could mean bad news for stocks in the near term,” Siddiqui said.
Optimism in stock markets has waned but remains above average for the sixth straight week in the latest American Association of Individual Investors (AAII) sentiment survey. In the week ending Wednesday, both neutral and bearish sentiment increased.
However, SoFi’s Young said there has been a significant “flip-flop” of investors becoming bearish and persistently bearish and moving into a bull camp. “Although the absolute level of bulls vs. bears on the chart doesn’t appear to be extreme, the almost instantaneous reversal in both cases is quite extreme,” she said (see chart below).
“In general, big and fast moves can be followed by big and fast moves back the other direction as markets and investors try to find some sort of middle ground,” Young said.
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