As we witness semiconductor stocks sharply retreating this week, the market reacts to news of potential restrictions from the Biden administration on exporting chipmaking equipment to China. Despite this, many small-cap stocks and non-tech Dow Jones stocks continue to climb, reflecting the ongoing vigor of this bull market. However, a closer examination of the broader investment cycle reveals indicators suggesting a more cautious long-term outlook. Investors should capitalize on current opportunities while remaining mindful of potential future challenges.
Record-Breaking Highs Amidst Narrow Growth
Last week, the S&P 500 achieved its 37th all-time high of the year, placing us in rarefied air. Historical data from Charlie Bilello at Creative Planning illustrates this unprecedented rise. With the S&P already hitting 37 highs halfway through the year, we’re on track to rival the 1995 record of 77 all-time highs. However, this surge has been predominantly fueled by a handful of Big Tech and AI stocks.
The recent cooling of the CPI report has redirected investment flows into new market sectors. Hypergrowth expert Luke Lango highlights this shift, noting the emergence of an “Everything Rally.” This rally, triggered by a softer June inflation report and dovish comments from Fed Chair Jerome Powell, has energized hopes for a “soft landing” for the U.S. economy.
Lango also suggests that the potential re-election of Donald Trump, perceived as more business-friendly than Biden, along with a robust Q2 earnings season, are further buoying market sentiment. He forecasts that while small caps should outperform, large caps will remain stable, and AI stocks—both builders and appliers—will rally. Additionally, rate-sensitive stocks like consumer discretionary, travel, biotech, real estate, and crypto should see significant gains.
Warning Signs Amidst Optimism
Despite the current market exuberance, historical patterns and valuation metrics caution against unbridled optimism. Long periods of market highs often precede stretches of underperformance. Indicators such as investor over-allocation to stocks and high CAPE (cyclically adjusted price-to-earnings) ratios suggest potential long-term challenges. The current S&P CAPE ratio stands at 36.43, the third highest in 150 years, indicating future returns may be below average.
Sentiment-Driven Gains and the Risks Ahead
Recent market gains have been driven not only by fundamental growth but also by bullish investor sentiment, pushing valuations to extreme levels. The S&P’s price-to-sales ratio now stands at 3, double its historical median, raising questions about sustainability.
While some investors might consider liquidating in favor of high-yield savings accounts, legendary investor Peter Lynch advises against it, noting that more money is lost anticipating corrections than during the corrections themselves. Instead, staying in the market while it remains bullish, with disciplined risk management, is advisable.
Strategic Adjustments for a Bullish Market
To navigate this market, consider rebalancing portfolios, especially for positions that have grown excessively large. For example, semiconductor ETFs with substantial gains may warrant partial profit-taking to reduce risk. Additionally, adopting a trading mindset over a long-term ownership perspective can be beneficial. This approach, advocated by investor Louis Navellier, involves capitalizing on short-term “flash trends” identified through quantitative analysis.
Conclusion: Enjoy the Gains but Prepare for the Shift
While today’s market may experience short-term selloffs, the overall bullish trend persists. However, investors should remain vigilant, recognizing that this bull market is treading on increasingly thin ice. The weight of the market’s gains will eventually become unsustainable, leading to a potential downturn. Until then, continue to capitalize on the current momentum, but stay prepared for the inevitable market shift.
