Anxiety is palpable in the U.S. stock market, despite the accumulation of market gains in recent times.
The persistence of high inflation levels is casting a shadow over the Federal Reserve’s inclination towards immediate interest rate adjustments. This hesitation comes at a time when consumers are grappling with skyrocketing grocery bills and exorbitant home and rental prices, which in turn, are squeezing their disposable income.
Nevertheless, the stock market continues its upward trajectory. Peter C. Earle, senior economist at the American Institute for Economic Research, highlights the remarkable performance of U.S. equities since late October 2023. During the period from October 27 to March 28, the S&P 500 surged by 28%, the Nasdaq witnessed a remarkable 30% increase, and the Dow Jones Industrial Average climbed by an impressive 23%.
Despite these gains, sustaining this momentum in the future may prove challenging. As Earle points out, the current economic landscape is fraught with uncertainties. Disinflation appears to be decelerating, concerns loom over employment stability, and consumer activity is showing signs of softening amidst tighter credit conditions. Furthermore, factors such as the depletion of pandemic savings and a rise in financial distress, including late payments and delinquencies, add to the complexities.
In light of these challenges, it seems that the market is pricing for perfection over the next 12-plus months, underscoring the cautious sentiment prevailing among investors and analysts alike.
The Stock Market Is Overvalued
“From a common-sense viewpoint, the equity markets came very far, very fast in 2023 and early 2024,” remarks Hugh Johnson, chairman emeritus of Graypoint LLC in Albany, New York. He underscores the rapid ascent of the equity markets during this period, emphasizing the need for a cautious perspective.
In assessing the level of risk, Johnson provides quantitative insights, revealing that the S&P 500 currently stands 14% above the level it should average in the current quarter. Looking ahead, the index remains 6.7% above the level it should average in Q4 2024 and even 0.5% above the level it should average in Q4 2025. These figures underscore the potential for market correction or consolidation in the coming quarters.
Furthermore, Johnson notes a notable shift in financial market performance over the past three weeks, leaning towards defensive sectors. Investors, in his view, have a tendency to gauge market sentiment accurately. This is evident in the recent sector performance, with utilities and consumer staples exhibiting strength, as well as in capitalization performance, where large-cap stocks have outperformed their smaller counterparts. Additionally, Johnson observes a resurgence in value investing, with value stocks once again outpacing growth stocks in terms of performance.
Big Technology Stocks Need to Hang On
Big technology companies with exposure to artificial intelligence (AI), such as Nvidia Corp. (ticker: NVDA), have played a significant role in bolstering stock market performance. However, there are concerns that this trend may not be sustainable in the long term.
Mitch Bodenmiller, portfolio manager and research analyst for Buckingham Advisors in Dayton, Ohio, highlights Nvidia’s remarkable performance in the first three months of the year, which has propelled it to become the third-largest stock in the S&P 500. Nvidia’s success has been a major driver behind the recent broad rally in the market.
However, Bodenmiller warns that the current level of support provided by companies like Nvidia may not last indefinitely. If Nvidia or other prominent technology firms, often referred to as the “Magnificent 7” stocks, were to miss earnings estimates or issue weaker-than-expected guidance, it could trigger a pullback from their current elevated levels. This underscores the potential vulnerability of the market’s recent gains, particularly if key players fail to meet market expectations.
In essence, while big technology companies like Nvidia have fueled the market’s upward trajectory, their continued dominance hinges on their ability to deliver strong financial results and guidance. Any signs of weakness or underperformance from these industry giants could lead to a reevaluation of their valuations and a subsequent market correction.
Key Market Benchmarks Are Triggering Confusion
Investors are grappling with several significant concerns as they navigate the current market landscape, with critical indicators suggesting a state of disarray.
Peter C. Earle, a senior economist at the American Institute for Economic Research, notes that both retail and institutional investors are closely observing the economic environment, which appears tepid. Many investors are pinning their hopes on the Federal Reserve maintaining its commitment to cutting interest rates three times this year. However, Earle underscores the irony that even if the Fed were to enact such rate cuts, their actual economic impact would likely be primarily psychological.
Earle explains that the effects of monetary policy changes typically have long and variable lags. Therefore, even if the Fed were to initiate rate cuts totaling 75 basis points, the tangible outcomes of such actions may not be felt until late 2024 or possibly even 2025. This delay underscores the complexities and uncertainties inherent in monetary policy adjustments.
Beyond monetary policy, investors face a myriad of domestic and geopolitical challenges. Ongoing conflicts in regions such as Gaza and Ukraine, coupled with escalating tensions between NATO and Russia, contribute to global instability. Additionally, the upcoming U.S. presidential election in November adds another layer of uncertainty to the market landscape.
Earle highlights the anomaly of certain market dynamics, such as the fact that the price of West Texas Intermediate crude oil is lower than it was in the weeks following October 7, despite ongoing geopolitical tensions and conflict. Moreover, the contentious nature of the upcoming U.S. election further adds to the uncertainty surrounding market conditions.
In the face of these uncertainties, stock markets have reached all-time highs, paralleled by a surge in the price of gold, which hit a record high of $2,186 per ounce on March 20. The S&P 500 also achieved a record high of 5,261.10 the following day. Earle emphasizes that these divergent asset prices tell contrasting stories about the market’s outlook.
Ultimately, the coming months will provide clarity on which of these implied forecasts proves to be more accurate. However, in the meantime, investors must navigate a landscape characterized by uncertainty, geopolitical tensions, and evolving economic conditions.
Consumer Angst Is Rising
The United States is witnessing a concerning trend of rising credit card delinquencies, indicative of consumers resorting to credit to cover essential expenses such as utilities, cell phones, mortgages, and rent.
According to data from the New York Federal Reserve, aggregate U.S. household debt surged by $212 billion in the fourth quarter of 2023, marking a 1.2% increase from the previous quarter. This surge has pushed household debt balances to a staggering $17.5 trillion, reflecting a substantial $3.4 trillion jump since 2019, just before the onset of the COVID-19 pandemic.
Of particular concern is the exceptionally high level of credit card debt, which reached $1.1 trillion in the fourth quarter, as reported by the Federal Reserve. Concurrently, the annualized credit card delinquency rate stands at 8.5%, starkly contrasting with the 3.1% delinquency rate observed across all outstanding household debt.
In a recent research report, investment strategists Liz Ann Sonders and Kevin Gordon of Charles Schwab highlighted the concerning trend of consumers “living beyond means” as evidenced by the surge in revolving credit and the associated increase in serious credit card delinquencies. This burden is especially pronounced among younger borrowers. While healthy wage growth has thus far kept the ratio of credit card debt to compensation relatively low, any deterioration in wage growth could exacerbate the situation by driving this ratio higher.
The implications of this trend extend beyond individual households, with potential ramifications for the broader economy. Sonders and Gordon caution that downbeat consumer sentiment could weigh heavily on stocks, considering that consumer spending constitutes approximately 70% of the Gross Domestic Product (GDP). Thus, the increasing strain on consumers’ financial health has the potential to reverberate throughout the economy, impacting various sectors and market indices.
Inflation Is Hanging Around
The trajectory of U.S. inflation numbers is unlikely to mirror the positive trend observed in 2023, signaling a potential shift in the Federal Reserve’s monetary policy stance.
Hugh Johnson expresses his belief that the improving inflation figures seen in 2023 will not persist. This change in the inflationary landscape provides sufficient rationale for the Federal Reserve to reconsider its plans for interest rate adjustments. Johnson suggests that the Fed may retreat from its previous intentions of implementing three interest rate cuts in 2024 and four cuts in 2025. He further anticipates a possibility of renewed weakness in economic and earnings indicators as 2024 progresses, with particular concern regarding the resurgence of inflationary pressures.
Mitch Bodenmiller echoes Johnson’s sentiment regarding the significance of inflation data as a key market catalyst. He emphasizes that any unexpected uptick in inflation figures could prompt the Federal Reserve to deviate from its anticipated rate cuts, potentially dampening the momentum of the market rally.
In summary, both Johnson and Bodenmiller agree that the evolving inflationary landscape poses a critical factor influencing the Federal Reserve’s monetary policy decisions and, consequently, market dynamics. Any deviation from expectations in inflation data has the potential to shape the direction of interest rates and impact market performance moving forward.
U.S. Government Spending Is Soaring
The economic fallout from the ongoing battle with COVID-19 has been staggering, with estimates pegging the toll at approximately $5 trillion and counting, equivalent to roughly a quarter of the nation’s gross domestic product (GDP). Moreover, the United States’ national debt has ballooned to a staggering $33 trillion, increasing by $1 trillion approximately every 100 days, according to the Committee for a Responsible Federal Budget.
Ron Surz, president of PPCA Inc. and Target Date Solutions in San Clemente, California, and co-host of the “Baby Boomer Investment Show” online series, highlights the precarious economic landscape. Despite encouraging signs at the start of 2024, Surz warns that these positive indicators may be short-lived. He points to a significant disparity between the M2, the Federal Reserve’s estimate of the nation’s money supply, and the amount he believes is necessary to effectively run the economy.
“Currently, $3.5 trillion represents too much money in circulation,” Surz asserts. He predicts that this excess liquidity will exacerbate inflationary pressures, compounding the existing “demand-pull” inflation with “cost-push” inflation.
Surz further observes that the Federal Reserve’s attempts to combat inflation through quantitative tightening are proving detrimental, leading to substantial operating losses. In January alone, the Fed reported an operating loss of $114.3 billion for the year 2023. Surz characterizes this situation as “ugly,” explaining that the Fed effectively “pays” for these losses by creating “deferred assets,” essentially issuing IOUs to itself with no clear solution in sight.
Adding to these economic woes is the looming threat of more U.S. banks failing and the increasing abandonment of office buildings and brick-and-mortar stores. Surz notes that as businesses shutter and default on loans, the banking sector faces mounting challenges. Additionally, depositors are withdrawing their savings in favor of higher interest rates offered by certificates of deposit (CDs) and money market funds, exacerbating liquidity concerns and further straining financial institutions.
Anxious About a Stock Market Crash? Stay the Course
Investing experts offer reassuring advice to anxious investors amidst market fluctuations, emphasizing the importance of maintaining a steady course.
Mitch Bodenmiller advises investors to resist the temptation to react to market highs by selling off stocks. Instead, he advocates for a steadfast approach of staying invested in stocks, especially those allocated for long-term growth. Attempting to time the market is discouraged, as it often leads to suboptimal outcomes.
Acknowledging the presence of red flags in the market, Bodenmiller underscores the significance of aligning investment decisions with one’s individual risk tolerance. It’s crucial for investors to assess whether their current asset allocation suits their risk appetite, ensuring they can remain committed during periods of market volatility.
Attempting to predict market movements is cautioned against as it veers more towards speculation rather than prudent investing. Bodenmiller emphasizes that this approach often results in subpar returns. Instead, investors are advised to maintain properly allocated investment portfolios and exhibit patience in navigating short-term market fluctuations.
In essence, the key message from investing experts is to remain calm and steadfast in one’s investment approach. By focusing on long-term goals, adhering to a suitable risk tolerance, and avoiding attempts to time the market, investors can navigate market uncertainties with confidence and resilience.