A growing chorus of warnings that equities are stretched is falling on deaf ears. Investors can’t get enough of AI stocks, and some are comparing this surge to the Dot Com boom of 24 years ago.
Of course there are differences. This time around, the technology segment of the market is in pretty good shape from a fundamental point of view. Both the AI 5 and most of the Mag 7 have real earnings, low debt and plenty of cash. That compares with yesteryear when many of the Dot Com stocks had no profits, no cash and in many cases no revenues.
However, as I wrote last week, all those fundamental variables that the likes of Warren Buffet rely on have been thrown out the window in today’s markets. Earnings reports this quarter have become a roulette game. A few cents difference in earnings or sales can see a company’s stock rise or fall by 20 percent or more. Some favored companies have seen their stocks gain 50 percent since the beginning of the year.
The speculative fever has crept into other sectors as well. Profitless tech stocks are running as are solar stocks that have been sold drastically over the last few months. Bitcoin and other crypto currencies have joined the party while other areas, such as commodities like gold and natural gas, are dropping off the charts.
Small-cap stocks, as represented by the Russell 2000 Index, have also come back to life. This area had enjoyed a 16 percent gain during the last quarter of 2023. That gave investors some hope that the rally was broadening out from the handful of meg-caps stocks. However, hopes were dashed as small caps languished since the beginning of the year until now.
Last week, I explained how markets were moving into a speculative stage of momentum buying. It is a risky trend that relies on buying stocks as they trend up, hoping to sell them to latecomers at much higher prices. It has little to do with what any company is worth. We had a taste on Tuesday of what can happen when momentum reverses.
The release of January’s Consumer Price Index (CPI) was slightly warmer than the market expected. The CPI rose 3.1 percent year-over-year instead of the 2.9 percent increase that was predicted by most economists.
In the grand scheme of things, the slight increase will have little if any bearing on what the Fed will do on the interest rate front. When it comes to economic statistics, economists will tell you that nothing falls or rises in a straight line and tiny moves in data points should be ignored. Not in a momentum-driven market.
Stocks went into free-fall. The S&P 500 Index at one point on Tuesday was down 2 percent. The NASDAQ fell more than that by the close, while the Russel 2000 fell almost 5 percent. That was the reaction on flea-size move in the CPI. Imagine what would happen to the market if something serious were to occur!
But it is still a bull market. Buyers rushed back into the same momentum plays and most of the losses had been recouped. On Friday, the Producer Price Index (PPI) also came in hotter than expected by an even wider margin. But given the sharp rebound in the markets after the CPI, traders were not as quick to reenact the bloodbath of Tuesday, as of this writing.
In my experience, the markets are telling me they are now in a “topping” process. One sign that should tell you when the rally is coming to an end is when markets sell off on good news.
Nvidia has been the poster child of this rally. The company will release earnings on Tuesday of next week. If, for example, results are better than expected, but the stock falls, that would be a telltale to watch out below. So far, I have not seen that kind of behavior.
As such, I can still see the S&P 500 continue higher, but the path ahead could be volatile. Another 100-plus points on the S&P 500 would not surprise me, but it is time to be a little more cautious. Stay invested but don’t chase. Let the FOMO crowd do the chasing and don’t get greedy.
Bill Schmick is registered as an investment adviser representative of Onota Partners Inc. in the Berkshires. He can be reached at 413-347-2401, or email him at [email protected].