The S&P 500 closed flat on Friday, the Dow declined 259 points while the Nasdaq 100 advanced 0.5% as bank declines overshadowed tech gains.
The financial sector was particularly affected by concerns surrounding New York Community Bancorp, which saw its shares tumble 8.2% following disappointing guidance.
Conversely, major tech companies such as Microsoft, Alphabet, Meta, and Amazon rose between 0.8% and 1.5% ahead of their upcoming earnings reports.
Additionally, Nvidia and TSMC ADRs increased by 0.8% and 6.9%, respectively, extending gains in the semiconductor sector.
On the data front, the University of Michigan consumer survey indicated that both sentiment and expectations have been revised upward, while inflation forecasts were adjusted downward.
Investment banks are beginning to publish their forward 12-month and beyond forecasts. The 20% plus appreciation of the S&P 500 year-to-date is a surprise to most market strategists. Although there are very few fundamental indications that the economy is headed for recession, many strategists are, at best, reluctant bulls.
Goldman Sachs published a forecast this week of 3% S&P 500 average annual returns (1% after inflation) for the next ten years. This subdued outlook is echoed by several major firms including JPMorgan.
Throughout market history, well-respected firms and people have made long-term bearish forecasts. In May 2009, bond king Bill Gross (PIMCO at the time) forecast risk assets would perform poorly in the U.S. He advised investors to focus on fixed income and international investments - he called his forecast the “New Normal.” Bill was entirely wrong.
Why are stock market strategists worried? The number one reason is high valuation. The market seems to be “priced to perfection.” The cyclically adjusted P/E ratio (CAPE) is 38x, ranking at the 97th percentile since 1930. If inflation, growth, interest rates, election results, earnings, etc. move in an unexpected direction, they see downside risk.
The chart below shows 5-year annualised performance for the S&P 500 at various 12-month forward P/E levels. The current high valuation of the market does have a high historical correlation with lower returns over a five-year period.
Market concentration is at its highest level in 100 years. Because of the law of large numbers, it becomes increasingly difficult for very large companies to maintain high rates of growth. If revenue and earnings growth rates slow (partly as a requirement of heavy AI capital expenditures) for Amazon, Google, Meta, Nvidia, Tesla, Microsoft, Apple, etc., the overall S&P 500 index earnings growth slows.
In the past five weeks, the 10-year treasury has climbed from about 3.6% to 4.2%. If interest rates continue to rise, S&P 500 multiples may decline and economic growth may slow.
On the other hand, it is hard to be a successful investor if one is consistently pessimistic. As of this week, the trend continues to be your friend and the trend is Bullish.