Stock Market Bubble Might Be Something Else Altogether

Of course, there’s more to the consternation than just one week. The S&P 500 just finished the first two months of 2024 up 6.87%, its best start to a year since 2019. And the
Nasdaq Composite,
for its part, closed the month at its first record high since November 2021. Valuations, at 20.6 times 12-month forward earnings, are also high relative to history. Torsten Sløk, chief economist at Apollo Global Management, notes that the median price/earnings ratio of the S&P 500’s 10 biggest stocks is higher than in 2020, 2010, and even the dot-com bubble peak in 2000, when it was about 25 times.

And there’s more to worry about than just big gains and nosebleed valuations. Disinflation is slowing. The Federal Reserve isn’t going to deliver the seven rate cuts that markets were expecting at the start of the year. Signs of froth are certainly showing in places like
Bitcoin,
which surged 23% over the past seven days and is just 6.4% below its record high, and single stocks like
Super Micro Computer,
which have ridden the artificial-intelligence hype to astronomical heights.

Even the concentration of the market’s gains in a handful of stocks—the Magnificent Seven—is seen as a reason to fret about the sustainability of the rally.

It’s time to stop worrying. For one, the economy continues to hold up far better than anyone has expected. Fourth-quarter gross domestic product was revised a touch lower, to 3.2% from 3.3%, but remains strong. That strength probably continued into 2024, with the Atlanta Fed GDPNow model pointing to 3% growth during the first quarter of the year. Inflation remains stronger than the Fed would like, but January’s personal-consumption expenditures price index “was an inflation data point that didn’t come in obviously hawkish,” writes 22V Research founder Dennis DeBusschere.

Investors, though, are still expecting that 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 are still taking a dim view on the world.

Long-only mutual funds have hedged their downside risk by keeping their exposure to economically sensitive stocks relative to defensive ones near their lowest level since the financial crisis of 2008-09, she writes. Hedge funds, meanwhile, are protecting themselves against a downturn in the market by keeping their “betas,” or exposure relative to the market, at similar levels. They’re also underweight stocks that would benefit from higher inflation and good economic news.

“[They’re] hedged against everything but positive tail risk,” writes Subramanian.

Even the market concentration doesn’t appear to be as big a risk as it would seem. John Kolovos, chief technical market strategist at Macro Risk Advisors, notes that it’s the S&P 500 as a whole, not the average stock in the index, that has been the big winner for investors over time.

Since 1998, for instance, the S&P 500 has gained 300%, while the Value Line Geometric Index, which he dubs a proxy for the average stock, has risen just 17%. He attributes this outperformance to the fact that the S&P 500, though an index, is more like an actively managed fund with a momentum bent—the winners get bigger, and the losers get the boot.

“While analysts like myself are correct when we say participation or breadth could be better, in terms of actually making money, we need to follow history,” Kolovos writes. “Do you want to be right, or do you want to make money?”

Instead of expecting the worst, investors should just accept that the bull market that began in October 2022 is only half over, at least based on history. The average bull market since 1930 has lasted 694 days, according to Ned Davis Research Senior Portfolio Strategist Pat Tschosik. The current one is only 344 days old, implying that it’s only at about its midpoint.

That means it could be time to follow the mid-cycle playbook, according to Nicholas Colas, co-founder of DataTrek Research. Mid-cycle refers to the period between the early stretch coming out of the depths of a recession and the late cycle, when the economy is heading for a slowdown.

Mid-cycle markets aren’t easy—as Colas describes it, they’re kind of boring. Volatility is low—the Cboe Volatility Index, or VIX, at 13.27 certainly meets that criterion—and returns tend to be solid and sometimes better than that. “This does not stop the bears from warning of imminent disaster, of course,” Colas writes. “That’s what they do, after all, even if they are wrong for years on end.”

So stop calling it a bubble—it’s just a run-of-the-mill bull market.

Write to Ben Levisohn at [email protected]