Wall Street has faced turbulent trading recently, highlighted by a notable increase in the CBOE Volatility Index (VIX), which measures anticipated volatility in the S&P 500. This index surged to 18 midweek, its highest level since April, reflecting investor anxiety amid a sharp decline in major technology stocks. This volatility indicates increased uncertainty and fear among investors as they react to market shifts.
A significant narrative in the market has been the rotation of investment from large-cap technology stocks to smaller companies. This shift is driven by expectations that smaller firms might benefit more from lower interest rates and the ongoing health of the economy. This change in investor sentiment comes amid waning enthusiasm for artificial intelligence (AI)-related stocks, which had previously been a major driver of market gains.
However, John Higgins, Chief Market Economist at Capital Economics, suggests that this narrative of a sustained rotation into small-cap stocks might not hold for long. Higgins argues that such a significant shift in investment strategies is likely to occur closer to the bursting of the current market bubble, which he predicts might not happen until 2026. He draws parallels with the dotcom bubble of the late 1990s, suggesting that, similar to the dotcom era, AI is seen as a transformative technology whose benefits investors are eager to realize prematurely. Consequently, Higgins projects that the S&P 500 could rise to 7,000 by the end of 2025 as the bubble reflates, leading to a price-to-earnings (P/E) ratio of 25, akin to the peak during the dotcom boom. The current forward P/E ratio of the S&P 500 is around 21, implying that valuation expansion will drive future gains.
For fund managers focused on value and cash flow, such as Chicago-based Distillate Capital, the current market environment poses challenges. Distillate’s recent update highlighted that its funds have lagged behind the market in 2024 due to their valuation-focused strategy. The firm uses free cash flow yield as a valuation metric, believing it helps avoid accounting distortions common in asset-light business models. Although free cash flow yield is less useful for short-term market predictions, it remains a critical tool for long-term investment decisions. Distillate notes that the S&P 500’s current trailing yield of 3.3% is relatively low compared to historical averages, suggesting that the market is currently more expensive than it has been 86% of the time over the past 40 years.
In broader market developments, U.S. stock indices have recently shown mixed performance. The S&P 500 has experienced a slight decline, while the Nasdaq Composite has fallen more significantly. Treasury yields have nudged lower, the dollar index remains steady, and commodity prices have seen minor fluctuations. For instance, gold is trading around $2,371 an ounce, while oil prices have dipped slightly.
Notable recent market news includes the Federal Reserve’s core personal consumption expenditures (PCE) price index, which rose by 2.6% year-over-year as of June. This figure remains unchanged from the previous month and continues to be a crucial gauge for inflation. Additionally, the SEC has charged short seller Andrew Left and his firm Citron Capital LLC for a $20 million scheme involving misleading stock recommendations.
In individual stock news, Bristol Myers Squibb’s shares surged following strong second-quarter earnings, driven by robust sales of its Opdivo cancer medication. Conversely, DexCom’s shares plummeted nearly 40% after the company reduced its full-year sales outlook. Deckers Outdoor saw its stock rise nearly 12% due to positive results from its Hoka and Ugg brands, prompting an upward revision of its profit outlook.
Overall, the market is navigating a period of heightened volatility and shifting investment strategies, with significant attention focused on economic indicators, corporate earnings, and broader macroeconomic trends.