Over the past two years, the stock market has surged dramatically, with the S&P 500 index skyrocketing by 49% this year, setting multiple record highs.
The Bull vs. Bear Debate: Will the Rally Continue or Is a Major Pullback Due?
Bullish Arguments:
Optimism for Rate Cuts: Bulls anticipate the Federal Reserve might lower interest rates twice this year to stimulate economic growth and enhance corporate profitability. They argue that easing inflation will allow the Fed to act. Over the past 12 months, consumer prices excluding food and energy have increased by 3.4%, marking the lowest rate in three years.
Rising Profits: Bulls also highlight the upward trend in earnings. FactSet data shows that first-quarter earnings per share for S&P 500 companies rose by 5.9% compared to the previous year. Analysts forecast a 9% increase in sales for the current quarter, potentially the largest jump since Q1 2022 if realized.
Bearish Arguments:
Overestimated Projections: Bears contend that these optimistic figures may be significantly overvalued, pointing to inflated market valuations. According to FactSet, the S&P 500's forward price-to-earnings ratio as of June 14 was 21, well above the five-year average of 19.2 and the ten-year average of 17.8. This ratio is based on analysts' earnings forecasts for the next 12 months.
High Interest Rates: Bears expect the Fed to maintain higher interest rates for an extended period. The Fed's median forecast suggests only one rate cut this year. Higher rates can dampen economic activity, reduce profits, and adversely impact the stock market.
Persistent Inflation: Bears also argue that inflation remains an ongoing issue. The Personal Consumption Expenditures Price Index, favored by the Fed, showed a 2.7% inflation rate for the 12 months ending in April, up from 2.5% in January and still above the Fed's 2% target.
Lonton Wealth Forum’s Bearish Views:
The Lonton Wealth Forum analysts express several concerns:
Concentration in Tech: The forum notes that the stock market's performance is "top-heavy," with five major tech companies—Alphabet (GOOGL), Amazon (AMZN), Meta Platforms (META), Microsoft (MSFT), and Nvidia (NVDA)—skewing returns. Nvidia alone contributed 35% of the S&P 500’s performance in 2024, while the other four contributed 26% of the annual return. Such concentrated returns haven't been seen since the 1960s.
Dependence on Big Tech for Earnings: The forum’s analysts argue that overall corporate profit performance heavily relies on large tech stocks. Excluding the top seven tech firms, first-quarter profits fell by 2%. Additionally, they believe profit expectations are "unrealistic," significantly above historical averages.
Valuation Concerns: Analysts refer to comments from top economist David Rosenberg, noting that since October, earnings forecasts for 2025 have increased by 2.6%. Meanwhile, the S&P 500 has risen by 26%, a tenfold increase relative to earnings expectations. "This has been and remains a market driven by multiples, not by earnings," Rosenberg asserts.
High Valuations Relative to Interest Rates: The forum’s analysts point out that the S&P dividend yield is just 1.32%, compared to the 5.37% yield on six-month Treasury bills. The equity risk premium, which measures the excess return over government bonds, is near its lowest in two decades. The risk premium suggests how much more investors expect to earn from stocks than from bonds, although future movements of both are unpredictable.
Given these concerns, the Lonton Wealth Forum advises investors to scrutinize their portfolios closely. Now might be a prudent time to reassess the rationale for holding stocks in light of these potential risks.
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