This was the month when the crowd shifted decisively from fighting the bull to embracing it. The sheer persistence of the equity rally, with the S & P 500 up 16 of 18 weeks and refusing to succumb to supposed late-February seasonal weakness, has converted the cautious. The extreme torque in stocks levered to secular AI and anti-obesity trends has become tougher to resist. And, of course, the absence of any quit in the U.S. economic expansion, the unflinching appetite for corporate credit and faster-than-expected earnings growth have made it harder to sit out the rally. It’s no fun idly watching others have all the fun. Call it the “belief” phase of the bull market, when most participants have signed on to the prevailing positive price action and fundamental story line and are more willing to allow equity exposures to rise. To Scott Rubner, tactical trading maven at Goldman Sachs, the upshot in the near-term goes beyond mere belief. “U.S. equities have entered a period of euphoria,” he told clients last week, “which has proved impossible to call the top and analysts are upgrading their year-end price targets by the day given the Goldilocks and soft-landing narrative from the market.” Identifying euphoria, of course, is both art and science, and euphoric states tend to build a while before they give way to some harsh reality check. But it’s fair to point out the proliferation of excitable good feeling in various market pockets. We can see it in the extreme outperformance of momentum stocks, the feeding frenzy along the entire food chain of AI-tinged semiconductors, the mad grab for second- and third-derivative plays on the AI theme. (Nvidia’s dominance is obvious to all and now valued above $2 trillion by the market, thus the rush for Super Micro Computer, Dell Technologies, ARM Holdings and names too gamy and insubstantial to mention.) Call-options volumes are again surging, bitcoin’s run to a new high has awakened even the jokey “meme coins” and busted, heavily shorted consumer concept stocks (Beyond Meat, Sweetgreen) have gone vertical on a whisper of fundamental improvement. Still, there’s a case to be made that this all amounts to a bull market merely acting like one. There is always a “hey, you never know” energy that starts infusing parts of the tape after a rally has carried on a while. Even with the speculative fervor returning, it’s not yet comparable to the heedless go-go risk bid that prevailed from late 2020 into early 2021. And while it’s true that three more brokerage-house strategists hustled last week to lift year-end S & P 500 targets that were either approached or surpassed by the index two months into the year, the new median Wall Street target is just 5100 – nearly 1% below Friday’s close. Wall Street’s view Bank of America has long kept track of strategists’ consensus recommended equity allocation. Last week it ticked to 55%, slightly above its 15-year average but well shy of its late-2021 high, not to mention the stratospheric levels seen around the turn of the millennium. Similarly, BofA’s wealth-management clients have let their equity exposure climb back above 61%, exceeding the 20-year average but well shy of the highs registered near the S & P 500’s prior peak around 4800 in early 2022. And while the fast-money traders are gunning call options and flimsy “story stocks” again, overall flows into equity funds have yet to gather much pace. Still, by some lights, stocks’ valuation is one of the better sentiment indicators, and by that measure the investment community is pretty enthusiastic. The S & P 500 is now at 20.6-times forward 12-month earnings forecasts – yet another metric that’s high relative to history but still short of the 2022 peak, not to mention the skyscraping heights of the tech-bubble period more than 20 years ago. The Street is not ignoring the apparently challenging valuation backdrop, but many market handicappers have been busy in the past couple of weeks working to explain why it need not be scary. BofA’s quantitative equity research group starts off its take by saying “The S & P 500 is egregiously expensive vs. history,” at the 95 th percentile since 1900 based on trailing P/E, suggesting lower returns over the next decade. Yet, BofA’s Savita Subramanian goes on, “sentiment and surprise matter more: over a 3- to 12-month time frame,” and “we question the validity of comparing an index to its younger selves.” She argues that the far higher-quality composition of the S & P 500 today (less leveraged balance sheets and far lower earnings volatility) supports a higher valuation. Citi’s Scott Chronert is among those arguing valuation isn’t as extreme as headline index P/E would imply given the outsized weight of pricey mega-cap growth companies, with the market now sniffing out a coming earnings upturn for the typical stock, an argument for broadening of equity-market strength. Barclays Venu Krishna, in lifting his S & P 500 target to 5300 from 4800, argues, “We believe Big Tech earnings exceptionalism justifies a premium multiple for the group, while we see SPX ex-Tech as trading roughly in-line with fair value amid easing inflation headwinds and a shallower reset to economic growth.” And here’s RBC Capital’s Lori Calvasina: “Our S & P 500 valuation model continues to tell us that if inflation moderates, 10-year yields come in a bit, the economy recovers in the back half of the year, and the Fed cuts in the second half that the S & P 500 could end the year with a trailing P/E of more than 23. More simply, we continue to see elevated but not alarming P/Es in the S & P 500 broadly while the median P/E of the top 10 names in the index remains close to past peaks.” All of this is surely plausible. Valuation, never a good timing tool, has been rising secularly for decades, with higher highs and higher lows across cycles. And when earnings are growing, bond yields steady and the Federal Reserve’s next move on rates likely to be down, the market can typically avert severe valuation compression. Blind spot developing? Still, the commonplace rationalization of the optimism embedded in equity valuations can rightly be seen as a potential blind spot developing, even if it is merely one more element of the bull-market belief phase, which tends not to emerge just ahead of a major peak. Coming at a time when the S & P 500 is more than 13% above its 200-day moving average — pretty stretched — and we haven’t had even a 3% pullback since October. It can be tough to continue giving the market the benefit of the doubt when the bullish case is becoming the consensus. I’ve argued for months against two of the main complaints directed at the market – that it was dangerously concentrated in a half-dozen huge stocks, and that the rally was acutely dependent on the Fed cutting rates soon and deeply. The market is arguing otherwise. We’ve now seen three of the so-called Magnificent Seven stocks falter notably, and the slack has been taken up. The “right” cyclical sectors are leading (industrials and consumer discretionary in addition to tech), and the equal-weight S & P 500 is nosing toward its old high. And as for the Fed, the market has gone from pricing in six or so rate cuts this year starting in March to maybe three likely beginning in May or later, and the tape hasn’t suffered for it at all, thanks to better-than-expected growth and the comfort that the Fed has plenty of room to cut whenever it chooses. Tests passed, even if there’s no guarantee of acing the next ones. No harm in expecting an air pocket before too long, because eventually one arrives, even for semiconductor stocks that trade as if they’re scarce claims on a fabulous future world. Bottom line: It’s a bull market, which means the overshoots happen to the upside, and displays of tenacious strength like the past four months – especially around the turn of a year – have typically meant further upside in coming months. Stocks geared to “mid-cycle” conditions have been far outperforming groups linked to late- or end-cycle circumstances, which is comforting so far as it goes. While the S & P feels as if it has come a long way in a hurry – up 25% in four months – it’s only 7% higher than it was 26 months ago. So, it’s OK to believe, though it helps to be alert to any incoming signs such faith is misplaced.
