S&P 500 Keeps Rising To Defy Valuation Warnings: Markets Wrap

Track the global equity, currency and commodity markets here.

Rita Nazareth

12 Feb 2024, 10:25 PM IST

Scott Chronert, Citi U.S. Equity Strategist is bullish on S&P 500 earnings. He also explains why investors should "throw out" historical playbooks on investing in an election year.

(Bloomberg) -- Stocks moved decidedly higher as Nvidia Corp. led a rally in chipmakers, with traders awaiting key inflation data and a slew of Federal Reserve speakers.

After struggling for direction in the first hour of Wall Street trading, the S&P 500 extended its advance above 5,000. Defying concerns about an overstretched market, equities kept climbing on data showing the economy remains fairly resilient and a trend of disinflation will allow the Fed to start cutting rates. A report showing a drop in US consumer expectations for inflation over the medium term to the lowest level since at least 2013 also bolstered sentiment.

“This run to 5,000 has been supported by the fundamentals, with a soft landing looking increasingly likely and earnings season nicely exceeding expectations after a messy start,” said Jeffrey Buchbinder at LPL Financial. “A market trading over 20 times earnings seems high, but it’s reasonable if the US economy avoids recession and earnings grow double-digits this year which is not out of the question.”

The S&P 500 topped 5,040. Nvidia Corp. hit a fresh record to overtake Amazon.com Inc.’s market capitalization and become fourth most-valuable US stock. Arm Holdings Plc soared as much as 37%, extending last week’s rally that was fueled by a bullish forecast. Treasury 10-year yields were little changed at 4.18%. Bitcoin is flirting with a winning run last seen a year ago.

S&P 500 Keeps Rising To Defy Valuation Warnings: Markets Wrap

The next pressure point for markets is Tuesday’s consumer price index. The annual US inflation rate is forecast to have dropped to 2.9% in January from 3.4% the prior month, according to consensus estimates of economists surveyed by Bloomberg. That would be the first reading below 3% since March 2021, supporting a disinflationary trend that will determine the scope and timing of rate cuts.

Fed Governor Michelle Bowman reiterated the central bank’s benchmark lending rate is in a good place to keep downward pressure on inflation, and she doesn’t see a need to ease policy soon.

In the derivatives markets, traders started pricing in that the Fed will carry out just four — or five at the most — quarter-point rate cuts in 2024, only slightly more than the three penciled in by policymakers. That’s a sharp shift from the end of last year, when futures traders were wagering on seven such moves, anticipating the Fed would cut rates by a full percentage point more than it was telegraphing at the time.

“It’s important not to lose sight of the big picture, which is that continued disinflation should allow the central bank to start easing this year,” said Mark Haefele at UBS Global Wealth Management. “This is a significant change in the investment landscape, so we think it’s less important whether the Fed cuts three, four, or five times this year. Any of these scenarios should be a positive macro outcome for bonds.”

“Most people will be fixated on this week’s inflation numbers, but there’s also a potential tug-of-war between how extended the current market rally may be vs. the buzz surrounding the S&P 500 topping 5,000,” said Chris Larkin at E*Trade from Morgan Stanley. “While it’s true the S&P has often pushed higher after crossing ‘round-number’ thresholds like this one, it hasn’t always done it after the type of rally that has unfolded since late October.”

Since 1968, whenever the S&P 500 rallied at least 20% over a 70-trading-day period, which it did between Oct. 27 and last Thursday, more often than not it was lower two weeks later, Larkin noted.

Sam Stovall at CFRA says that considering the old adage that “large round numbers act like rusty doors and require several attempts before finally swinging open,” investors now wonder if it is time to take some profits.

If history is any guide, while short-term digestions of gains have indeed occurred, they have been fairly short in duration. When looking at the S&P 500’s cumulative return in the 3-, 6-, and 12-months after crossing above the 100, 500, 1,000, 2,000, 3,000, and 4,000 levels, the S&P 500 posted average price gains of 4.7%, 9.8%, and 12.3%, and rose in price during 83% of all periodic observations, he noted.

Last week’s news and data reinforced the four drivers of this bull market: Fed rate cuts by May, solid economic growth, continued disinflation and strong earnings, according to Tom Essaye at the Sevens Report.

“It’s important to acknowledge that this rally has been driven by actual good news and bullish expectations being reinforced by actual data,” Essaye said. “At the same time, the risks that kept investors worried in October (and even throughout 2023) haven’t been vanquished — they simply haven’t shown up, yet.”

Source: DataTrekSource: DataTrek

The S&P 500 is currently trading around 20 times forward earnings — a level it has only hit in two other periods over the last 25 years: the dot-com bubble and the post-pandemic bull market, said Nicholas Colas at DataTrek Research.

“Valuations get to these levels when investors have high confidence in three factors: monetary/fiscal policy, the US/global banking system, and strong corporate earnings,” Colas added. “Even with 2022’s bear market, investors feel that the future is highly predictable. It will likely take an exogenous shock to change their minds.”

“Keeping the age-old adage in mind that ‘trees don’t grow to the sky,’ we think it’s important to keep the party hats in the box for now,” said John Stoltzfus at Oppenheimer Asset Management. “We remain positive on stocks, view bonds as complimentary to stocks for prudent diversification and look for a further broadening of the equity rally which emerged from the lows of late October last year.”

To Rob Swanke at Commonwealth Financial Network, some caution is warranted at the current valuation levels.

“I wouldn’t say we’re in bubble territory, but the market is pricing closer to perfection now and companies will have to continue to hit high earnings targets in 2024, something they didn’t have to do in 2023,” he added.

Corporate Highlights:

The Federal Reserve slapped Citigroup Inc. with a series of demands to change the way it measures the risk of its trading partners, according to a Reuters report, the latest blow to Chief Executive Officer Jane Fraser’s turnaround effort.
Diamondback Energy Inc. agreed to buy fellow Texas oil-and-gas producer Endeavor Energy Resources LP in a $26 billion cash-and-stock deal to create the largest operator focused on the prolific Permian Basin.
Gilead Sciences Inc. agreed to purchase CymaBay Therapeutics Inc., a developer of an experimental liver disease drug, for $4.3 billion in equity value.
Hewlett Packard Enterprise Co. is seeking as much as $4 billion from Autonomy Corp.’s former bosses following a London judge’s finding that they fraudulently boosted the value of the company before its sale.

Key Events this Week:

Germany ZEW survey expectations, Tuesday
US CPI, Tuesday
Eurozone industrial production, GDP, Wednesday
BOE Governor Andrew Bailey testifies to House of Lords economic affairs panel, Wednesday
Chicago Fed President Austan Goolsbee speaks, Wednesday
Fed Vice Chair for Supervision Michael Barr speaks, Wednesday
Japan GDP, industrial production, Thursday
US Empire manufacturing, initial jobless claims, industrial production, retail sales, business inventories, Thursday
ECB President Christine Lagarde speaks, Thursday
Atlanta Fed President Raphael Bostic speaks, Thursday
Fed Governor Christopher Waller speaks, Thursday
ECB chief economist Philip Lane speaks, Thursday
US housing starts, PPI, University of Michigan consumer sentiment, Friday
San Francisco Fed President Mary Daly speaks, Friday
Fed Vice Chair for Supervision Michael Barr speaks, Friday
ECB executive board member Isabel Schnabel speaks, Friday