Over the past two years, the stock market has experienced remarkable growth, with the S&P 500 index surging by 49% and achieving multiple record highs. This stellar performance has sparked a heated debate among investors: will this upward trend persist, or are we on the brink of a significant correction?
Bullish Outlook: Rate Cuts and Earnings Growth
Optimists believe the Federal Reserve is poised to cut interest rates, potentially twice this year, which would stimulate economic activity and boost corporate profits. They argue that easing inflation provides the Fed with room to maneuver. Consumer prices, excluding volatile food and energy costs, rose by 3.4% over the past year, marking the lowest increase in three years.
Furthermore, bullish investors highlight the ongoing rise in corporate earnings. According to FactSet, the S&P 500 saw a 5.9% increase in per-share profits in the first quarter compared to the previous year. Analysts predict a 9% rise for the current quarter, which would be the largest gain since early 2022.
Bearish Concerns: Valuations and Persistent Inflation
However, not everyone shares this optimistic view. Skeptics argue that current valuations are overly ambitious. As of mid-June, the forward price-earnings ratio for the S&P 500 stood at 21, significantly above the five-year average of 19.2 and the ten-year average of 17.8. This ratio is calculated based on analysts’ earnings forecasts for the next 12 months.
Bears also anticipate that the Fed will maintain higher interest rates for an extended period. Recent Fed projections suggest only one rate cut this year, contrary to the multiple cuts some bulls expect. Elevated rates can dampen economic growth, hurt corporate profits, and ultimately drag down stock prices.
Additionally, inflation remains a concern. The personal consumption expenditures price index, a preferred inflation measure by the Fed, registered a 2.7% increase over the past year through April, up from 2.5% in January and still well above the Fed’s 2% target.
Doug Kass’ Warning on Market Risks
Doug Kass, a seasoned hedge fund manager and columnist for TheStreet Pro, stands firmly in the bearish camp. Kass highlights several critical issues:
- Concentration of Market Gains: Kass notes that a few large-cap tech companies, including Alphabet (GOOGL), Amazon (AMZN), Meta Platforms (META), Microsoft (MSFT), and Nvidia (NVDA), are disproportionately driving market returns. Nvidia alone has accounted for 35% of the S&P 500’s performance in 2024, with the other four companies contributing an additional 26%. This level of concentration hasn’t been seen since the 1960s.
- Dependence on Mega-Cap Tech: Corporate profit growth is heavily reliant on these tech giants. Excluding the seven largest tech stocks, there was a 2% decline in first-quarter profits. Kass argues that profit expectations are unrealistically high compared to historical averages.
- Valuation Concerns: Kass, echoing economist David Rosenberg, points out that earnings forecasts for 2025 have only increased by 2.6% since October, while the S&P 500 has surged by 26%. This disparity suggests the market’s rise is driven more by multiple expansions rather than actual earnings growth.
- Equities vs. Interest Rates: Kass warns that stocks are rarely as overvalued relative to interest rates as they are now. The S&P 500’s dividend yield is 1.32%, while the six-month Treasury bill yields 5.37%. The equity risk premium, the excess return over Treasury bonds, is at its lowest in nearly two decades.
Given these factors, Kass advises investors to scrutinize their portfolios carefully and reassess their reasons for holding stocks in this environment.
Conclusion
As the debate between bulls and bears intensifies, the future of the stock market remains uncertain. While some foresee continued growth fueled by potential rate cuts and rising earnings, others warn of overvalued stocks and persistent inflation risks. Investors should stay informed and consider the diverse perspectives before making investment decisions.
