A Rally with Over $6 Trillion Spectators on the Sidelines
Wall Street loves to put out price targets for the market. Being that the S&P 500 is the benchmark index, I thought it would be a good topic to highlight this week after the major average traded above 5,100 and closed at a record high of 5,088 last Friday. It’s a good time to take stock of the stock market’s strong move higher for the first two months of 2024. As of this writing, UBS has the highest projection among the leading global brokerages, raising their target to 5,400, which represents a further advance of around 6% from its current level.
Given that there are 10f months left in a presidential election year, it seems Wall Street might be about as wrong about the strength of this bull market as it was about calling for a recession. There are some compelling factors that should be considered at this point as milestones are being recorded faster than most have expected. FactSet stated on Feb. 16 that, “the forward 12-month price to earnings (P/E) ratio for the S&P 500 is 20.4. This P/E ratio is above the 5-year average (19.0) and above the 10-year average (17.7).” Stripping out the Magnificent Seven and FAANG (Facebook, Amazon, Apple, Netflix and Alphabet) collectively, the S&P 500 is trading at a multiple of 15x, meaning the rest of the market is far from being overvalued, based on the forward 12-month earnings per share (EPS) of $250 for the S&P 500.
Because Wall Street embraced a recession of some degree as a sure thing, money has been piling up on the sideline, to where current estimates stand at $6.1 trillion. Granted, cash sitting idle earning 5.0-5.5% in money markets, certificates of deposit (CDs), short-term Treasuries and agencies is no joke for guarantee of principle, but seeing what is shaping up to be one of the great stock market opportunities of all time unfold is no joke either. In reality, the S&P 500 is up by only 5.9% from January 2021, before the artificial intelligence (AI) phenomenon.
To put some color on this rally, consider the following: The S&P Global US Manufacturing PMI is compiled by S&P Global from responses to questionnaires sent to purchasing managers in a panel of around 800 manufacturers. The Composite PMI in World increased to 51.80 points in January from 51 points in December of 2023, and the preliminary reading for February is 51.50. This piece of data is widely recognized as a leading indicator of business conditions. It includes sub-indices related to business output, new orders, employment, costs, selling prices, exports, purchasing activity, supplier performance and backlog of orders. It’s a good gauge of changing worldwide business conditions that has been rising since October. It’s a bullish trend.
The current amount of margin debt of around $771 billion in the stock market is nowhere near the high of Q4 2021 when margin debt topped $935 billion. Three of the four major averages are hitting all-time highs without the use of overleverage. To be sure, the cost of borrowing money to buy stocks is expensive. Margin rates are up in the 6-8% range at most of the big brokers. Traders are more likely to utilize margin for short-term gains.
The bond market has retreated with yields backing up across the curve, and yet, equities in all the 11 market sectors have been trading higher for the past two weeks, recouping the big one-day losses incurred on Feb. 13 from the hot Consumer Price Index (CPI) number. For those critics who claim the market is being led by only a handful of mega-tech stocks, they need to look to some strong participation in the industrial sector, non-bank fintech and big-cap healthcare stocks that demonstrate the market is indeed broadening out.
Indeed, there is also the positive impact mergers and acquisitions (M&A) has on investor sentiment, with some sizeable deals crossing the tape. Capital One is buying Discover for $35 billion. Diamondback Energy is acquiring Endeavor Energy, the largest private operator in Permian for $26 billion. Owens Corning plans to buy Masonite for $3.9 billion and Chord Energy plans to merge with Canada’s Enerplus valued at $11 billion. The fresh deal flow for M&A is almost always bullish for markets as it draws attention to who’s next.
Comparing historical returns can be helpful, but also a hindrance on whether to put money to work in the stock market following a move to new highs. Investors caught up in looking in the rearview mirror as a guide might miss out on further gains when there are transformational catalysts at work, namely AI, record dry powder on the sidelines and a Fed positioned to lower rates later this year. Some years the market doesn’t play by the historical rules, with 2024 looking like it could be another very impressive year.
With earnings season mostly complete, FactSet reports that for Q4 2023 (with 79% of S&P 500 companies reporting actual results), 75% of S&P 500 companies have reported a positive EPS surprise and 65% of S&P 500 companies have reported a positive revenue surprise. First-quarter guidance has been very mixed, with many of the biggest and best companies within each of the 11 market sectors pointing to a solid first quarter of top- and bottom-line growth. It would be of no surprise to see some consolidation during the next two to four weeks or to see some technical pullback and filling and digesting the data covering inflation, employment, retail sales, consumer sentiment, housing, factory production and a Federal Open Market Committee (FOMC) meeting slated for March 20.
This period also gives investors the opportunity to see how the bond market reacts to further hefty Treasury auctions. The $16 billion 20-year Treasury auction held last week was not well received, where dealers had to step in and take in 21.2% of the sale. This is the stock market’s boogeyman: the $34 trillion in U.S. federal debt. For all the good indicators for the stock market to trade higher, this issue carries the type of risk that can derail a good equity market. Something to think about and definitely something to take very seriously considering the size of the debt and who’s going to buy it all.
