The record-breaking performance of U.S. stocks despite ongoing issues such as surging inflation, potential tightening of Federal Reserve policy and a slowdown in corporate profit growth has raised concerns among investors.
The S&P 500 index, for instance, has more than doubled its value since the onset of the COVID-19 pandemic in March 2020. It previously reached a total of 65 all-time highs in 2021, making it the second-highest number of highs in a single year, according to data from LPL Financial.
The Dow Jones Industrial Average has also experienced a significant increase of 72.3 percent in three years since hitting its lowest point in March 2020, according to Dow Jones Market Data. The NASDAQ Composite has seen substantial growth as well, advancing over 70 percent during the same period.
As previously noted, however, despite the positive performance, some investors have expressed concerns about potential areas of excessive growth. They perceive these as indications of an overheated market, such as the remarkable stock gains of companies like Tesla and Nvidia and the high valuation of electric vehicle manufacturer Rivian despite limited revenue.
In addition to those indications to consider, the tech sector’s valuation, measured by forward price-to-earnings ratios, is approaching a 17-year high.
As a result, some investors seek valued stocks and market areas that are not overvalued. Walter Todd, chief investment officer at Greenwood Capital in South Carolina, said he has been “trying to gravitate” to valued stocks and market segments.
“But as somebody who has been doing this for a while, [the market] seems… excessive in certain respects,” Todd said.
Concerns over market instability
The concerns have impacted the market, with stocks exhibiting instability recently. This instability risks the S&P 500’s sixth consecutive week of positive returns.
On Wednesday, the CBOE Market Volatility Index, often known as Wall Street’s fear gauge, reached its highest monthly level.
In a note on Monday, Morgan Stanley strategists highlighted that the S&P 500 should be valued at around 20.5 times forward earnings estimates based on the 10-year U.S. Treasury yield level. This number differs from its current valuation of 21.5 times.
“We think retail flows, seasonal strength and institutional ‘FOMO’ [fear of missing out] have taken valuations above fair value.”
Morgan Stanley strategists
Some investors believe the notable increase in consumer prices, reaching the highest level in over 30 years, could accelerate the Federal Reserve’s reduction of bond purchases and eventual interest rate hikes.
This potential acceleration could put pressure on stocks and other high-risk assets. It is worth noting that the central bank has recently begun scaling back its $120 billion government bond-buying program.
The University of Michigan’s Consumer Sentiment Index, released on Friday, revealed a significant decrease in U.S. consumer sentiment in early November. The index reached its lowest level in ten years, and this decline can be attributed to the impact of rising inflation on households’ living standards.
Investors will redirect their focus in the coming year as the projected S&P 500 earnings growth slows to 7.5 percent. This deceleration comes after an estimated remarkable rebound of 49 percent this year, which occurred in the aftermath of the pandemic-induced shutdowns.
In the last month, Chad Morganlander, a portfolio manager at Washington Crossing Advisors, has reduced his stock holdings. He has adjusted the equity exposure in certain portfolios from an overweight position to neutral while increasing allocations to cash and bonds.
Morganlander mentioned that investors had been compensated due to the Federal Reserve’s accommodative monetary policies.
“The real question is what to do now,” he said. “Our viewpoint is that you want to try to be a little less risky.”