Why Investors Should Be Concerned About the Market’s ‘Invincibility Syndrome’
The recent performance of the stock market has investors buzzing with optimism. The Dow Jones Industrial Average (DJIA) recently celebrated its 39th record close of the year, while the S&P 500 (SPX) hovers just 0.3% below its peak, and the Nasdaq Composite is only 1.5% away from setting new records. Despite these encouraging signs, hedge fund manager Michael Grant raises alarms about what he terms an “invincibility syndrome” gripping Wall Street.
The Roots of ‘Invincibility Syndrome’
Michael Grant, co-chief investment officer and head of long/short strategies at Calamos Investments, based in Naperville, Illinois, warns that the perception of U.S. equities’ invincibility is becoming a dangerous norm. With $33.7 billion in assets under management, Grant understands the market dynamics at play. He attributes much of the optimism to large tech companies, which investors consider particularly attractive against a backdrop of global economic fragmentation.
Historical Context: The Crescendo of Market Peaks
Historically, the ‘invincibility syndrome’ tends to emerge when markets are nearing significant peaks. “This syndrome signals a crescendo,” Grant points out, noting that market tops can often be elusive, especially compared to market bottoms that typically occur amid investor panic and market stress. “Investor optimism, however, can become a chronic condition, leading to extended equity summits marked by exhausting narratives across various styles and sectors,” he adds.
Alarming Valuation Metrics
Grant highlights several concerning metrics indicating that the market’s exuberance may be misguided. The Shiller cyclically adjusted price-to-earnings (P/E) ratio for U.S. equities has exceeded 35, making it the third highest on record. This level is only surpassed during times when bond yields were unusually low. Furthermore, the median P/E multiple of the S&P 500 stands at 28, a number that recalls the dot-com bubble of 1999.
Additionally, price-to-sales ratios are returning to levels not seen since the market’s euphoric highs of early 2021. Consumer sentiment also supports this trend; the Conference Board’s three-month moving average has hit a record high for American consumers’ outlook on stock performance over the next year. The bullish stance of newsletter writers monitored by Mark Hulbert showcases a similar narrative, depicting the highest levels of optimism since 2000.
The Dangers of Overoptimism
While investor sentiment is indeed bullish, Grant cautions that extreme optimism does not accurately reflect risk levels. “When everyone is already bullish, what remains to drive the market higher?” he questions. Current global cash holdings are also at historic lows. Despite some claims of $6 trillion in money-market funds set to enter the stock market, Grant argues that this cash equates to nothing exceptional when measured against equity capitalization. He points out that cash as a percentage of equity mutual fund assets has reached historical lows, indicating a concerning lack of liquidity.
Potential Catalysts for Market Correction
Grant identifies several factors that could spell trouble for the prevailing optimism in the market. Contrary to the widespread consensus, he believes that the idea that only a recession can derail the bull market is misguided. He cites the bear market from 2000 to 2003 as a case where recession was a result rather than a cause of asset price deflation. The expectation among investors that S&P 500 earnings will grow by 10% to 15% through 2025 relies heavily on a continued robust economic outlook, which may be overly optimistic.
In this scenario, Grant argues, the Fed would not necessarily need to lower the federal funds rate below 3% or reduce the 10-year Treasury yield below 3.5%. The acceptance that the decline of long-term risk-free yields is over could exert substantial pressure on stock valuations. He suggests that a push for the S&P 500 to reach the 6000 mark implies that 2024 could be exceptionally rewarding for U.S. large-cap equities—yet he warns that this notion pales in comparison to the growing evidence that the markets may be nearing a critical summit.
Final Thoughts
Michael Grant’s observations serve as a crucial reminder for investors navigating the current market landscape. The ‘invincibility syndrome’ is indicative of a potentially precarious situation, where peak valuations and unchecked optimism create an environment ripe for correction. The cyclical nature of financial markets implies that changes in sentiment can happen abruptly and with significant impact. With this in mind, prudent investors should remain vigilant, questioning prevailing narratives and assessing risks as they navigate this volatile terrain.