A wave of optimism continues to ripple through financial markets as strong corporate profits, rich equity valuations, and narrow credit spreads fuel investor confidence. But some analysts are beginning to question whether the market’s recent run-up masks growing investor complacency.
What Happened: According to DataTrek Research’s morning briefing, written by co-founder Nicholas Colas on Sunday, the “S&P 500 net margins are creeping their way back to recent peak levels,” that is 13% which was last seen in 2021 during the pandemic, while the “Shiller PEs are at 2020s highs (39x),” referring to the cyclically adjusted price-to-earnings ratio.
Colas says that strong profits and high stock valuations reflect investor belief that “S&P 500 profitability will remain very high for the foreseeable future, causing structurally higher returns on capital and, therefore, valuations.”
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Meanwhile, the bond market appears to be echoing a similar outlook, with the “BBB (lowest investment grade rate) bond spreads” at just 0.2 percentage points over IG or investment grade paper. Colas notes that this figure is “just 0.01 points above their post-pandemic lows.”
Narrow spreads such as these typically signal that investors see little near-term credit risk, often taken as a strong vote of confidence in individual companies, as well as the broader economy.
However, Colas notes that cracks might be forming beneath the surface, with the data section of the report highlighting the fact that “US Q2 earnings season is coming in strong everywhere except the amount by which companies are beating earnings,” which he attributes to mounting margin pressure.
“Last week’s selloff in the dollar and how many rate cuts Fed Funds Futures now expect,” he says, hinting that monetary policy developments could add to this uncertainty.
Why It Matters: Investors have turned more bearish over the past couple of days, with the AAII Sentiment Survey last week showing that the bull-bear spread has collapsed to just 0.3%, the lowest since September 2022, following which the markets witnessed the steepest fall since the 2008 financial crisis.
According to the survey’s results, the bullish sentiment dropped to 39.3%, while the bearish sentiment surged to 39.0%, which also reflects investor indecision.
Price Action: The SPDR S&P 500 ETF Trust (NYSE:SPY), which tracks the S&P 500, was up 0.42% on Friday, closing at $637.10, and is up 0.48% after hours.
Photo Courtesy: Kanyapak Lim on Shutterstock.com
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