By The stock market’s impressive three-month run appears to be reaching its peak, signaling a potential decline in the near future. The S&P 500, which has rallied 16% since October, now hovers around 4760, nearing its all-time high of 4796. However, several factors suggest that the market may be running out of steam.
Expensive Market and Decreasing Yields
One key reason for buyer hesitation is the market’s current level of expensiveness. The S&P 500 is trading at around 19 times analysts’ forecasts for companies on the index in the coming year. This multiple is close to its highest point since early 2022 when the Federal Reserve began raising interest rates. Higher rates diminish the value of future profits, making stocks less attractive.
Moreover, the high multiple implies that for every $19 invested in the index, investors only receive a $1 payout in earnings, resulting in a mere 5.3% yield. In comparison, the almost risk-free 10-year Treasury note offers a 4% yield without the volatility associated with the stock market. The slim 1.3 percentage point premium for investing in stocks seems historically low.
Lack of Bearish Sentiment Increases Risk
Another concerning factor is the lack of bearish sentiment among stock investors. According to a survey conducted by the American Association of Individual Investors, approximately 20% of respondents expressed bearish views. This percentage is close to its lowest level since at least 2018, indicating a predominantly bullish market sentiment. However, this optimism could lead to a potential buying slump as most investors who intended to invest have likely already done so, especially considering higher valuations and increased risk.
As the stock market shows signs of losing momentum and becoming overpriced, investors should proceed with caution. The current state of the market suggests that a decline may be on the horizon, and it is crucial to carefully evaluate investment strategies in light of these factors.
Is a Market Correction on the Horizon?
According to Evercore strategist Julian Emanuel, it is likely that we will see a market correction in the first half of 2024. He suggests that investor confidence may soon waver, leading to a potential sell-off.
Interestingly, there appears to be room for bets against the market to increase. Currently, there are approximately 100 million shares being shorted in the SPDR S&P 500 exchange-traded fund, which represents about 10% of the total shares. This is one of the lowest levels of short interest since 2018. In comparison, the highest short interest in the past six years was recorded in 2020 with around 240 million shares. If more short sellers enter the market by disposing of their borrowed shares, it could have a significant impact on stock prices, causing them to slide.
There’s reason to believe that this selling pressure could happen sooner rather than later. Profit forecasts indicate a potential drop in earnings. In January alone, the S&P 500’s aggregate earnings-per-share estimate has already decreased by approximately 3%. Historically, earnings-per-share estimates tend to drop by 10% in an average year dating back to 1997. Given this trend and the anticipated impact of rising interest rates on consumer and business demand, it is possible that analysts will further lower their projections. Wells Fargo, for example, expects a decline of 7% to 9% in net interest income this year due to a potentially weakening economy.
Considering these factors, it might not be the most opportune time to heavily invest in stocks. When analyzing the current market conditions and outlook, it appears that caution may be warranted.
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