How might one improve upon perfection? It’s an eternal query for the metaphysical mind and a timely one for the here-and-now investor, after the stock market has feasted for months on a near-ideal set of conditions. An adorable Goldilocks economic expansion, enough global disinflation to constrain bond yields in a benign range, lavishly generous credit markets and a clear upturn in earnings growth might be enough to explain the S & P 500 hitting further record highs last week and logging a 25% gain since late October. But on top of that rich bounty, the Federal Reserve seems prepared to start trimming the policy rate by summertime, exercising a well-earned prerogative to “normalize” rates in economic peacetime with stocks at a record rather than fight a battle against a macro downturn with markets under stress. Add in the fast-flowing enthusiasm for AI-enabling semiconductor stocks and the weight-loss miracle drugs, and we have a market that’s been riding waves of belief that good things are afoot, dealing out increasing rewards and defanging a succession of risks along the way. With all that, though, Friday’s market action furnished a tentative hint that the rally might have reached one of those “enough for now” moments, when prices and attitudes catch up to, and possibly surpass, the pileup of positives. After an early pop following a just-right jobs report showing moderate employment growth, rising labor supply and decelerating wage gains, the S & P 500 was jolted by some of the market’s fastest horses breaking stride. Nvidia unwind The headlong aggression of momentum-stock buyers in recent weeks has been one of the few decent reasons to expect this sturdy, tightly ordered rally to start trading a bit more loosely and unreliably for a time. While only one day’s action, the severe Friday reversal in Nvidia shares (from up 5% to down 5% within six hours on eye-watering trading volume) was a fitting preview of what a potential momentum unwind would look like. NVDA 1D mountain Nvidia, 1-day Nvidia has been the speedy flagship of this exuberant AI theme, adding $1.5 trillion in market value in the past year and last week coming within sight of Apple’s weight within the S & P 500. As many enjoy pointing out, Nvidia’s valuation has come down over that span, from 60-times forward earnings to 34, as revenue and profit projections have exploded. That’s reassuring so far as it goes, though at some point the market will start to express doubt about the long-term sustainability of these growth rates through a less-generous P/E. And even though the likes of Amazon and Tesla are more highly valued, we have no other precedent for a $2.2 trillion market cap company (Nvidia’s current size) sustaining a 34 times forward P/E. Relevant or not, the stock at Friday’s high touched a trend line going back more than six years, connecting short-term highs from early 2018 and late 2021, lending some credence to the “enough for now” idea. The main characteristic of Nvidia lately has been as the largest beneficiary of a relentless momentum-factor trade – buying what’s worked best and shunning the laggards. Momentum stocks It’s a feature of this market that extends beyond semiconductors, and even tech in general. Within retail and staples Costco has gone vertical relative to the sectors (until Friday). In pharma, it’s Eli Lilly. In basic materials, Martin Marietta Materials and Vulcan Materials. This long-term chart from 3Fourteen Research shows the percentage of S & P 500 market cap attributable to the 100 highest-momentum stocks of the prior 12 months, looking pretty maxed out. This is part of the case for expecting some turbulence, a reshuffling of market leadership, perhaps even a proper pullback at some point. The S & P 500 Volatility Index finished the week near 15 and is in a clear three- month uptrend from its mid-December low near 12, even as the S & P 500 has gained 10% since then. Hedgers and speculators are attuned for a possible break in the calm, or perhaps simply accounting for a higher-velocity tape. And yet, all of that said, nothing in Friday’s wobble or the overall setup suggests playing for a radical change in market tone right away or with high conviction. In fact, Friday the market minimized the headline damage to a mere two-thirds-percent dip in the S & P 500 through its signature rotational impulse. Laggards Apple and Alphabet perked up in the momentum unwind, up/down volume was evenly split and consumer cyclicals held firm. There were 674 new 52-week highs across the NYSE and Nasdaq against 110 new lows. Just about all of the trend indicators are reassuring, if extended. These include the market’s admirable ability to stay persistently overbought without even a 3% setback in more than four months, confirmation from strong global equity indexes, the equal-weight S & P 500 and mid-cap benchmark making new record highs. The broad array of sentiment and positioning metrics have surely nudged up to the “excessive optimism” range, yet so far without quite getting firmly into the danger zone. And in bull markets, such mood and risk-appetite metrics can stay elevated for quite a while. Some indicators — such as speculators remaining net short S & P 500 futures and brokerage strategists’ muted index targets — imply the helpful wall of worry is not quite fully scaled. Market behavior so far in 2024 has been pretty close to some of the better risk-vs.-reward years in recent memory, in terms of the angle and magnitude of S & P 500 gains into March, including 2017, 2013 and 1995. In each case the market was emerging from more than a year of strenuous macro and policy tests, with mid-cycle dynamics supporting equity values. And, most crucially, the macro weather remains favorable. Nominal GDP growth running near a 5% annual pace, 10-year Treasuries around 4% and 12-month forward earnings estimates at a record all amount to a fundamental and psychological cushion against the first notable market pullback deepening into something nasty. Pullback near? The tricky part is sorting out how this comfortable macro moment has been priced to produce future returns. In most respects the market is behaving in “mid-cycle” fashion. As Nick Colas, co-founder of DataTrek Research has said, these are periods when markets are generally stable, up-trending and often dull. It can be hard to watch the market seem to discount the same broadly consistent favorable conditions day after day. It’s fair to observe that the market doesn’t not appear cheap, unloved or under-exploited at this point. Citi strategist Scott Chronert calculates that the market is currently priced for 11.6% annual free-cash-flow growth for the S & P 500 over the next five years. Such a heady pace, he says, “seems attainable, but implicit expectations are high and leave little room for softness over the medium term.” This weekend is the 15 th anniversary of the generational post-financial-crisis bear-market bottom in March 2009. Since then, the S & P has delivered a 16.7% annualized total return, even after two bear markets and two other severe/prolonged corrections. It can surely get a bit better; the 15-year annual return starting with the August 1982 start of that secular bull market exceeded 19%. The chart above shows there’s still headroom to the top of this megatrend path. And the S & P is only up 7% from its high 26 months ago, hardly in thin air. For sure, eventually the pendulum tends to swing from a period of fat to lean years. The trailing 15-year return on the day of the March 2009 bottom was only 4.4% and the index was lower than it had been 12 years earlier. An excellent entry point that did not look that way to most. In other words, in the grand scheme the market doesn’t owe investors much from here and there’s a good deal of house money in on the table. But that alone doesn’t mean that payback time is nigh.
Nvidia’s terrible Friday gives traders a preview of what a momentum unwind would look like
Mar 9, 2024
