Published June 14, 2024
Below is a good overview of the state of the stock market from MarketWatch and Apollo.
“Twenty-nine. That’s how many new records the S&P 500 SPX has registered so far in 2024, having closed at a new peak on Thursday (though lower futures on Friday suggest it may not make 30 this session).
Hopes for interest rate cuts later this year and excitement over AI have helped propel the bull run.
And yet, there are many reasons to be wary right now, say the bears. First, an obvious short-term technical one. The 14-day relative strength index of the Nasdaq 100 NDX, whose big tech constituents have been powering the rally, has moved up to 77.5, well above the overbought threshold of 70.
Meanwhile, the market is relying on a narrowing breadth of big cap stocks, which, as the The Chart segment later in this note shows, are notably more expensive than their small-cap cousins.
Those of a bearish nature can rattle off additional concerns. For example Doug Kass, founder of hedge fund Seabreeze Partners Management, says in a new note his worries include that corporate profit expectations are currently “unrealistic” and comparing the S&P 500 dividend yield with Treasury yields means stocks have “rarely been as overvalued against interest rates as they are today.”
Kass also reckons domestic political risk is underestimated, investor sentiment remains bullish and fear is absent, while “market structure and investor positioning are potentially toxic market influences.”
Ian Culley, investment analyst at All Star Charts, says this week’s action, when stocks on Wednesday jumped after soft inflation data then fell back on Fed comments, shows the “market’s still a mess.”
What’s needed, then, is a guide that can see through the daily machinations and give a strong clue to underlying investor sentiment. He suggests keeping an eye on action in high-yield bonds for “risk-on confirmation.”
The chart below shows the iShares iBoxx $ High Yield Corporate Bond ETF HYG above the line that gives the performance of the Invesco S&P 500
High Beta ETF SPHB relative to the Invesco S&P 500 Low Volatility ETF SPLV.
The SPHB tracks 100 stocks from the S&P 500 with the highest sensitivity to market movements, or beta, over the past 12 months. The SPLV tracks 100 securities from the S&P 500 with the lowest realized volatility over the past 12 months.
As the chart makes clear, the stock market’s risk appetite dovetails very neatly with attitudes towards more risky corporate bonds.
“When investors feel comfortable buying bonds that could end up a zero, riskier stocks with a higher beta outperform their safer alternatives,” says Culley.
“If the Nasdaq’s new all-time highs are the real deal, HYG should break out of its six-month consolidation and print a new year-to-date high,” he says. “A decisive break above 78 will confirm the risk-on stock market rally.”
The chart
A study of forward price/earnings ratios for S&P 500 stocks ranked by market cap shows that large-cap companies are notably more expensive than small caps.
Torsten Sløk, Apollo chief economist, says this is because higher costs of capital are weighing on highly leveraged small-cap companies with low coverage ratios, while the AI story has boosted valuations of mega-cap names.
“With the Fed keeping interest rates higher for longer, and the AI narrative pushing valuations and index concentration to extreme levels, the downside risks to equities are growing,” says Sløk.
Market Update
The meeting of Federal Reserve governors took center stage this week. A few months ago, investors expected interest rates to be cut at this meeting. But stronger economic data and sluggish inflation have dashed those hopes pushing out rate cut expectations to year-end. Ahead of the Wednesday meeting, stocks ticked +0.2% higher Monday with market-darling Nvidia trading after a 10-for-1 stock split. Tuesday’s stock market was powered higher by shares of Apple. The company’s launch of its AI technology sent shares surging +7%. That sent the Nasdaq higher by +0.9%. Wednesday’s report on consumer price inflation showed a 3.3% annual inflation rate, better than expected, and enough to cheer investors. The report gave the Fed room to express optimism about the path of inflation sending bond yields lower. Stocks rallied broadly with the S&P 500 rising +0.9%. Stocks rose +0.2% further Thursday as tech stocks continued their push upward. Shares of semi/software company Broadcom rallied +12% a day after software maker Oracle jumped +13%, both showing the market’s preference for AI and strong growing tech companies. Of note, small cap stocks gave back almost all of their Fed-related gains Thursday as weakness plagued non-tech areas of the market. The downward reversal in small cap shares is of particular note because the group is viewed as being much more sensitive to interest rates. Though rates have fallen hard this week on tamer inflation, it hasn’t helped the small cap sector. The suggestion being that other market forces are keeping investors averse to taking risk. They view investing in the mega-cap tech stocks as safer. Software company Adobe became the latest to surge after earnings, rising +15% in Friday’s trading. Stocks in Europe were hammered this week after a surprisingly strong showing from far right parties led to political uncertainty ahead of upcoming elections. Ten-year bond yields have fallen from 4.6% to 4.2% over the past three weeks and now look to be clearly trending downward.
Stocks pushed further into new high territory with the S&P 500 (SPY) gaining +1.63% while the Nasdaq 100 (QQQ) lifted +3.51%. As noted above, small cap stocks (IWM) diverged from the market strength reversing downward to lose -0.93% for the week.
Warm wishes and until next week.