April 22, 2024
Stock Market

5 Signs Bullish Investors Are Fueling Bubble


Lance Roberts has three words to describe the current stock-market environment: “This is nuts.”

Roberts, the CIO of RIA Advisors, said in a February 27 note that bullish investor psychology has gotten out of hand, and the sharp upward momentum is putting stocks at risk of entering a bubble.

The S&P 500 has continued its 16-month rally so far in 2024, rising more than 8% year-to-date to a record high. Much of the gains have been thanks to mega-cap stocks, especially Nvidia, as earnings have come in hot.

But signs of broad speculation are showing as well, Roberts said. One is that there are 75 stocks across various industries in the S&P 1500 that are trading at price-to-sales ratios above 10. For context, the S&P 500’s average price-to-sales ratio is 2.7, which is also considered historically elevated.

Another is investor sentiment indexes. He cited the Charles Schwab Trader Sentiment Survey, which shows retail investors are much more optimistic than they were a year ago. According to the Q4 survey, 53% of retail investors are bullish on stocks, compared to 32% in Q4 2022.

Other surveys show heightened exuberance as well. CNN’s Fear & Greed Index is in “Extreme Greed” territory, the highest possible category. And the American Association of Individual Investors’ Sentiment Survey shows 46.5% of investors are bullish, above the long-term average of 37.5%. Meanwhile, only 21.3% of investors classify themselves as bearish, below the long-term average of 31%.

Roberts shared a chart showing the 13-week net average of the AAII’s survey. It shows investor sentiment is approaching highs going back to 2005.

aaii survey

RIA Advisors

There are also technical indicators that reflect elevated sentiment, he said. Here’s the S&P 500’s overbought/oversold indicator, which is a composite index of multiple technical indicators. It’s right about at all-time highs, meaning momentum is about as strong as it gets.

overbought oversold sp500

RIA Advisors

The S&P 500 and its short-term moving average are also starting to surge above its long-term moving average.

moving averages

RIA Advisors

Finally, market volatility is exceptionally low, as shown by the CBOE’s Volatility Index, commonly known as the VIX.

“The compression of volatility remains a critical near-term concern. While low levels of volatility have become increasingly common since the financial crisis due to the suppression of interest rates and a flood of liquidity, the lack of volatility provides the ‘fuel’ for a market correction,” Roberts said.

vix

RIA Advisors

While a crash may not be imminent, Roberts cautioned about postponed consequences the more the market melts up.

“Unsurprisingly, investing in the market is not a ‘risk-free’ adventure. While there are many opportunities to make money, there is also a history of wealth devastation,” he said. “Therefore, understanding the environment you are investing in can help avoid potential capital destruction.”

How close are stocks to bubble territory?

Opinions vary on how close stocks are to being in a bubble.

Ray Dalio, the billionaire founder of Bridgewater Associates, said this week in a LinkedIn post that stocks are not in a bubble — not even the mega-cap Magnificent Seven that have been fueled by the excitement around AI.

Here is Dalio’s bubble gauge, current levels of which are nowhere near 1929 or 1999 highs.

bubble gauge

Ray Dalio

“The ‘Magnificent 7’ has driven a meaningful share of the gains in US equities over the past year,” Dalio said. “The market cap of the basket has increased by over 80% since January 2023, and these companies now constitute over 25% of the S&P 500 market cap. The Mag-7 is measured to be a bit frothy but not in a full-on bubble.”

He continued: “Valuations are slightly expensive given current and projected earnings, sentiment is bullish but doesn’t look excessively so, and we do not see excessive leverage or a flood of new and naïve buyers. That said, one could still imagine a significant correction in these names if generative AI does not live up to the priced-in impact.”

Bank of America’s Michael Hartnett has said the AI frenzy is in the early stages of bubble formation and that rising 10-year Treasury yields, alongside a surging Nasdaq, have historically been a bubble sign. Meanwhile, Societe Generale’s Albert Edwards has pointed out that for the first time since 2000, at the peak of the dot-com bubble, the information technology sector’s market cap makes up a third of the S&P 500’s total market cap.

tech stocks

Societe Generale

Investing legend Jeremy Grantham also recently warned that stocks are due for a devastating crash.

Major Wall Street banks do not see much upside left for stocks, although several of them have already had to raise their year-end price targets. Goldman Sachs and JPMorgan see the S&P 500 hitting 5,200, representing about 1% upside. Morgan Stanley, meanwhile, has one of the more bearish targets at 4,500, representing 12% downside from current levels at 5,137.

What stocks do in the months ahead will continue to depend on macroeconomic conditions and earnings data. But like Roberts is warning, the more exuberant investors become, the more pain they may experience down the road.



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