The eternal question of how one might improve upon perfection is not just a philosophical pondering, but a timely consideration for investors in today’s stock market. With the S & P 500 hitting record highs and enjoying a 25% gain since late October, it seems like the market has been feasting on near-ideal conditions. A Goldilocks economic expansion, global disinflation, generous credit markets, and a clear upturn in earnings growth have all contributed to this impressive rally.
However, the recent market action has provided a hint that perhaps the rally has reached a point of saturation. After a strong start following a positive jobs report, the market experienced a reversal, with momentum stocks like Nvidia taking a hit. Nvidia, a flagship in the AI theme, has seen significant growth in market value over the past year, but the market may start to question the sustainability of this growth at some point.
The market has been driven by a momentum-factor trade, with investors buying what has worked best and shunning laggards. This has led to a concentration of market cap in the highest-momentum stocks, raising concerns about a potential pullback or reshuffling of market leadership.
While indicators of sentiment and positioning are elevated, they have not yet reached a danger zone. The market has shown resilience and strength, with various trend indicators pointing to continued bullish sentiment. However, the market may be pricing in future returns based on high expectations for free-cash-flow growth, leaving little room for softness over the medium term.
As we reflect on the 15th anniversary of the post-financial-crisis bear-market bottom in March 2009, it’s clear that the market has come a long way. While there is still potential for further growth, investors should be mindful of the cyclical nature of the market and the possibility of a pullback in the future. The market may not owe investors much at this point, but that doesn’t mean that payback time is imminent. Investors should proceed with caution and be prepared for potential shifts in market dynamics.
