In an era characterized by elevated interest rates, geopolitical instability, and consumer sentiment entrenched in a recessionary bunker for the last two years, one might incredulously assess the stock market’s persistent ascent, appreciating at over twice its historical rate. Yet, the prevailing consumer malaise belies realities revealed in their spending habits and financial statements, suggesting that the foundations of a long-term bullish market remain intact.
Despite the understandable nerves gripping short-term traders, who have witnessed six successive weeks of gains in the S&P 500—culminating in a commendable nine percent increase—the cautious historical perspective should temper immediate volatilities. The last rally of 6 consecutive weeks into mid-July was swiftly succeeded by a brief 11 percent correction. While signs of speculative excess are manifesting in certain sectors, notably the CNN Greed Index, which has registered moderate overbought signals, these fleeting indicators do not preclude further market gains before an overdue correction arrives.
Option traders can offer short term sentiment clues worth watching. Like the Greed index, we see signs that Bullish Call option buyers are slightly over their skis, setting up the potential for a one-to-4-week correction. However, such a setback in this long-term Bull market may require even lower put/call ratios and higher stock prices.
The Fund Manager Surveys (FMS) present a somewhat alarming perspective for cautious Bulls. The percentage of managed assets held in cash has plummeted to an 11-year low of just 3.9%. This indicates that professional investment managers have their clients nearly fully invested, contrasting with the staggering $6.4 trillion consumers are sheltering in money market accounts. Traditionally, such low cash levels among institutional players can signal a lack of ammunition for further stock investments and a potential market peak, though historical precedents illustrate that timing such peaks is notoriously precarious. Today’s high liquidity and low debt service conditions may push the financial cliff much further down the road.
A particularly confounding aspect of the current economic tableau is the persistent torpor plaguing consumer sentiment, even as asset values have surged. The recent labor strikes at Boeing and among longshoremen underscore a vibrant labor market where workers are demanding substantial concessions – and winning. While robust real wage growth and favorable credit scores should herald a revival in consumer outlook, the unexpected, excessive fiscal and monetary stimuli unleashed in 2021 and early 2022 have cast a long shadow of discontent. Though inflation rates have receded from their 40-year highs, the psychological scars remain fresh as consumers struggle against lofty price levels.
Looking ahead, however, the promise of a buoyant economy appears to loom large. Such negative psychology is more indicative of a bottom than a top in the economy and stock market. As interest rates edge closer to pre-pandemic norms—unhindered by economic deceleration—optimism should blossom, coaxing broader investor participation beyond the current largescale growth stock concentration. The ensuing two years may indeed see revitalized sentiment across a wider swath of the market, such as small and mid-cap stocks that have been more restrained than we expected as interest rates fell over the summer. For now, growth stocks and AI related tech sectors dominate.
Valuation metrics, however, provoke a dissonant chord among investors. The price-to-sales ratio of the S&P 500 Index has returned to the pre-bear market highs of late 2021, a threshold associated with the significant Bear market decline of 2022. Nevertheless, the pronounced focus on technology, particularly artificial intelligence (AI), sustains a justification for these elevated valuations, despite concerns that they may indicate frothiness. The infrastructure buildout of power generation, transmission and data centers will take years thus the stock market may have miles to go before it sleeps.
Disparities emerge when contrasting the capitalization-weighted S&P with its equal-weight counterpart, which exhibits more grounded valuations. As policymakers continue to champion reshoring initiatives, small-cap value businesses, long neglected, might find themselves within the purview of renewed investment as interest rates begin to ease.
When we remove the extraordinary weighting of tech giants like Apple, Amazon, Nvidia and Microsoft from the SP and observe equal weighted large/mid/small capitalization indices, it’s clear that valuations are below their median levels. The Government backed reshoring of companies to the US in the next leg of this Bull market should finally soldier the values of small cap value businesses to the front lines, especially when interest rates subside.
Much of the forecasting miscalibration in 2022 and 2023 arose from an inadequate appreciation of the depth of monetary and fiscal stimulus in motion. Institutions like Morgan Stanley, which anticipated a 16 percent decline in S&P earnings for 2023, humbly missed an 18 percent earnings surge to record levels. We foresee sustained upward momentum in both earnings and equities into 2026, supported by a resilient economy.
The phenomenon of robust business formations illustrates the vivacity of American entrepreneurial spirit when infused by the animal spirits of trillions in free money. The post-pandemic influx of capital, bolstered by declining interest rates, is manifesting as a resurgence in startup culture. Despite potential vulnerabilities within new manufacturing sectors, the bipartisan consensus to boost industrial activity and reshore supply chains renders a supportive backdrop for stimulative policies. Without a new wave of significantly higher inflation and lending rates, this economic tailwind should continue.
Although private equity deal volumes waned by roughly 40 percent in 2023 from the frenetic activity of 2021, this correction merely recalibrates back to pre-pandemic norms rather than signaling a gut-wrenching downturn. Deal volumes are rising as interest rates fall. The first three quarters of 2024 witnessed a marked acceleration in global M&A activity, registering a 27.6% increase in deal value and 13.3% growth in deal count from the year before.
There were a backlog of Private Equity exits growing during the high-interest rate environment since 2022 as the average Buyout firm held their acquisitions a record 7 years in 2023. This is now being worked off as General Partners have reduced their acquisition exits to reach a 5.8-year duration. Still elevated, but in line with the 5-year average. The consensus for large declines in borrowing costs and interest rates could super charge 2025 – 2026 M&A activity. Assuming inflation does not rebound too much, and lending rates continue to fall longer term, it’s likely that the large sidelined institutional funding pool will find an increasing number of attractive opportunities to acquire.
Concurrently, asset generation stemming from American free-market capitalism continues to defy detrimental policy rhetoric. As much as the political elite threatens to kneecap success, corporate America increasingly dominates the Globe, and households are reaping rewards with total assets testing record levels near 9 times their liabilities. Despite looming fiscal debt challenges, the economy shows no immediate signs of economic hurricanes in this expansion cycle.
Leading indicator proxies such as inverted yield curves and industrial surveys have been misleading the debate between a future hard landing recession and a no landing economic flight path. The optimists should be given the benefit of doubt as supported by the stellar earnings reports in every quarter this year. The evidence is clear: in the third-quarter earnings season, 79 percent of S&P 500 companies reporting have surpassed earnings expectations, with a median 6% beat, elucidating a narrative far removed from doom and gloom. Record earnings and profit margins, low default rates amongst consumers and business, strong credit quality, easing lending standards don’t justify the glum outlook shown in surveys. If these trends remain true and we continue with a No Landing – no recession economy – for the next year or two, then adopting a Bullish outlook with rising earnings and equity valuations is warranted. Short-term of course we are quite vulnerable to a 4% or greater correction before the Bull stampede approaches a cliff. One must always be wary of investor consensus about stocks, and the contrarian should be sanguine about muted investor enthusiasm short-term and the record amount of cash they are enjoying high yielding no risk Treasury bond yields.
As we navigate ahead, a discerning eye on market dynamics is warranted. While a correction of four percent or more feels plausible in the short term, the broader bull market narrative remains compelling. The AI-driven rally, which sparked in October 2022, paired with a more expansive rise in major indexes starting in late 2023, signals a multifaceted recovery. The two-way market that some desire in order to take profits and redeploy assets at lower levels has been disillusioned. While indications are primed for a clear short to medium term overbought indication upon the next run to new highs near S&P 6000, the large cap universe is showing few signs of a meaningful peak. The investment landscape appears ripe for those willing to endure periodic tremors, as broader sectors, such as small caps, await their turn to partake in the escalating rhythms of a new economic chapter nourished by liquidity and optimism in 2025.
