Analysis: US stocks may not be in a bubble, but a pullback could be imminent

By | March 13, 2024

By Lewis Krauskopf

NEW YORK (Reuters) – Some market participants believe the relentless U.S. stock rally is ready for a breather, even as it remains unclear whether stocks are in a bubble or a strong bull run.

The benchmark S&P 500 index is up more than 25% in the past five months, a phenomenon that has happened only 10 times since the 1930s, according to BofA Global Research. In a rally led by stunning gains at chipmaker Nvidia, the S&P has already hit 16 record highs this year, the most in any first quarter since 1945, data from CFRA Research shows.

Bullish investors argue that these gains come from solid fundamentals, rather than the kind of rampant speculation that accompanied past bubbles. Commonly cited reasons include a strong U.S. economy, expectations that the Federal Reserve will cut interest rates this year and excitement about the business potential of artificial intelligence.

Still, some investors believe the market’s near-continuous rise means a pullback is coming. The last time the S&P 500 fell more than 5% was in October, although BofA data shows that such selloffs historically occur an average of three times a year. The index is up 8.5% this year.

“A lot of good news is priced into the market,” said Michael Arone, chief investment strategist at State Street Global Advisors. “From my perspective, this just suggests that the risks are skewed to the downside.”

It’s not immediately clear what could trigger a market sell-off. While stronger-than-expected inflation has dented expectations about how deeply the Fed will cut rates this year, many believe borrowing costs will still be lower. Increased consumer prices are also seen as evidence of economic strength.

Investors have largely dismissed other concerns, from instability in U.S. regional banks to China’s weak economy.

Nevertheless, some indicators flash with a warning. The S&P 500’s weekly relative strength index (RSI) — which measures whether stocks are overbought or oversold — has risen to just above 76, a level rarely surpassed since 2000, data from Miller Tabak shows.

Significant selloffs followed the last two times the index exceeded these levels: a 10% decline in the S&P 500 in January 2018 and a 30% drop when COVID-19 emerged after the index reached that level in January 2020.

“None of this means we’re looking at a big long-term top,” said Matt Maley, chief market strategist at Miller Tabak. “It does tell me, though, that we are becoming ripe for a material pullback.”

Growing optimism among investors has also raised concerns. The percentage of investors optimistic about the six-month outlook for stocks rose to 51.7% in the latest weekly survey from the American Association of Individual Investors. This is only the fourth time in almost the last three years that the bullish level has risen above 50%. .

High optimism is often seen as a contrarian indicator because it means the bar for positive surprises is higher.

“The sentiment backdrop right now makes the market vulnerable to a decline,” said Kevin Gordon, senior investment strategist at Charles Schwab.

History shows that current progress may be ready for a pause. The S&P 500 recovered losses from the previous bear market when it hit a record high on January 19, and has risen about 7% since then.

That’s consistent with previous rallies, when stocks continued to rise after hitting new highs. However, these moves were followed by declines of at least 5% in the 12 times such a situation occurred, says Sam Stovall, CFRA’s chief investment strategist.


For some, the market’s optimism — coupled with parabolic moves in shares of Nvidia and other AI-focused companies — has evoked comparisons to previous periods when asset prices soared to unsustainable highs only to collapse, such as the meme stock rallies of 2021 and the 1999 dotcom boom.

Nvidia shares are up more than 80% this year, after tripling by 2023, making it the third most valuable US company. Other AI-linked stocks have posted huge gains in the past year, including Super Micro Computer, which is up 300% and is poised to join the S&P 500.

Nvidia has shown a strong relationship with the performance of the S&P 500, JPMorgan strategists wrote.

“We caution investors that this relationship is likely to work in reverse when AI euphoria peaks,” the strategists said.

Others, however, note differences from past bubbles.

Keith Lerner, co-chief investment officer at Truist, wrote that the S&P 500 tech sector’s three-year outperformance versus the broader S&P 500 is about 30%.

That roughly matches the 30-year average and is far from the peak of just above 250% in March 2000, Lerner said.

And there appears to be little evidence of euphoria in the new issue market, where IPOs have remained relatively subdued.

Only 54 companies had IPOs in 2023, compared to 311 in 2021, before the S&P 500 peaked in January 2022, said Nicholas Colas, co-founder of DataTrek Research.

“Sentiment toward equities has warmed since mid-2023… but is nowhere near the bullish levels of previous market peaks,” wrote Savita Subramanian, equity and quantitative strategist at BofA Global Research. The bank recently raised its year-end target for the S&P 500 from 5,100 to 5,400. The index closed at 5,175.27 on Tuesday.

“We think this bull market has legs,” she said.

(Reporting by Lewis Krauskopf; Editing by Ira Iosebashvili and Richard Chang)

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