Published May 24, 2024
One of Wall Street’s last remaining bears threw in the towel this week when Morgan Stanley’s Michael Wilson raised his outlook for the stock market. This came after Mr. Wilson warned for over a year that the market was vulnerable and the economy shaky. The data has been anything but concerning so far in 2024 with consumer spending remaining strong and investors ever-more confident. Stocks have delivered an average year’s worth of gains in less than six months.
The question becomes whether and when investors become TOO confident. The two charts below show that complacency has arrived, though it can go on for quite a long time.
The first chart shows that the VIX volatility index, hitting a value below 12 recently, is trading at its lowest level in over four years. The VIX index spikes on fear and worry, dropping to lower levels as that fear dissipates. Over the course of the prior decade, the VIX routinely held between 10 and 15, a very low level. Are we beginning a similar extended period of investor calm? Investors are convinced that interest rates will be coming down. But as we have noted many times, this will require an easing in the economy. Will investors get the near-impossible scenario of a gentle ease economic growth – not too strong, not too weak?
Perhaps a broader measure of investor concern is the bond market’s credit spread. The credit spread is the additional yield that investors require for taking on added risk. For example, investors can get a 5% return by investing in the “risk-free” asset of U.S. Treasury Bills. The chart below shows that investors require an additional +3% on average to take the substantial added risk of investing in the bonds of lower-grade companies. When investors feel positive about the future, they demand less compensation for the added risk, viewing that risk as actually quite small.
Invariably something comes along to bring risk back into the market. We never know what that will be. For now, investors appear to believe the outlook is sunny and the risk of investing in stocks and bonds quite low. A contrarian would say that it is times like these, when investors undervalue risk, that are in fact the times to be most concerned.
Market Update
Investors focused this week on earnings from AI chip juggernaut Nvidia, due out Wednesday evening. Monday saw markets continue their recent rebound with a +0.7% addition to the Nasdaq while the broader market traded flat. Metals furthered their upward climb with copper hitting a record high. But interest rates also rose ahead of the release of Fed Reserve meeting minutes midweek. A +0.3% tick higher in stocks Tuesday though the rally in metals stocks skidded. Copper has been on a tear as AI investment in data centers is driving a sharp rise in spending on the metal. Fed meeting minutes Wednesday sent stocks down -0.3% as the central bank members confirmed a willingness to raise interest rates if inflation becomes more problematic. Inflation data in recent weeks has supported an easing of rates at some point, though markets keep pushing out the timing of that easing as economic data continues to come in strong. After the close, Nvidia crushed earnings estimates yet again as AI-driven purchases of their chips remain stratospheric. The stock rose +9% Thursday to help the Nasdaq overcome a broad-based decline elsewhere in stocks. 10 of the 11 market sectors lost ground Thursday when a report on manufacturing and service activity showed that portion of the economy expanding at a two-year high. The broad market S&P 500 slipped -0.7%. Stocks bounced back Friday as a final report on consumer sentiment improved from an earlier reading and durable good orders supported a moderate economic view. The S&P 500 recovered +0.7% while the Nasdaq added +1%.
A fifth straight week of gains for stocks with the Nasdaq 100 (QQQ) adding +1.37%. The S&P 500 (SPY) was flat on the week while small-cap stocks (IWM) slid -1.27%.
Warm wishes and until next week.