Market sets record — Breaking down whether the bulls are in the clear or a peak is imminent

Published Sat, May 18 20249:18 AM EDT

You can't argue with a market making new record highs, though it's fair game to interrogate the tape about its assumptions and intentions. Stocks completed a round trip and then some over the course of seven weeks, a shakeout of over-aggressive investor positioning at the end of the first quarter and a test of Wall Street's avid faith in an ideal soft economic landing. Test passed, for now, with the help of a friendlier set of inflation numbers, another show of earnings overachievement by big companies and a reversal of the April Treasury yield surge. With the Dow Jones Industrial Average closing above 40,000 for the first time Friday and the S & P 500 settling above 5,300 after hitting a fresh all-time high Wednesday, the advice of history suggests not overthinking it. Record closes are more to be respected than feared when they arrive. Keith Lerner, strategist at Truist, marks up a long-term S & P 500 chart to show times when it was at an all-time high. Clearly, records tend to persist, though a painful exception is the brief and untrustworthy visit to unprecedented heights in 2007. Even as we all rightly point out that the Dow inching above 40,000 is an arbitrary number on a highly imperfect market gauge, Ned Davis Research says forward returns after the Dow eclipses a new big, round number have been handily better than average over the subsequent month and year. Last week's run past the March 28 peak also insured that the market would not repeat, at least not in close detail, the failed comeback from a similar 5% decline last August. It briefly seemed that minor retreat would be enough to refresh the advance, only to have another burst of inflationary concern and punishing bond-yield surge undercut the indexes by a full 10% over the next two months. Breaking down the latest advance The latest comeback has been sufficiently broad to win points from those who monitor supply-demand clues, with three-quarters of all stocks up in recent weeks and the average one up 5%, according to Bespoke Investment Group, versus the nearly 7% gain in the S & P 500. Bank stocks have been among the strongest groups, with the broader financial sector reaching a new high Friday, always a positive feature of any rally. Junk-bond spreads are remarkably compressed, almost as tight as they've ever been relative to Treasury yields. The fact that Federal Reserve has kept interest rates steady at cycle highs for an unusually long stretch (ten months and counting), while the economy has grown above trend and inflation has mostly declined suggests a pretty good policy setting. .VIX mountain 2019-01-01 The CBOE Volatility index since the start of 2019 The CBOE S & P 500 Volatility Index (VIX) – reflecting demand (or lack of it) for volatility protection over the next month - closed under 12, its lowest finish since November 2019. What could go wrong? Something could surely come along — an ugly inflation report later this month or a less-than-fabulous Nvidia outlook next week — to make these placid, comfortable conditions appear in retrospect like misplaced confidence and an underpricing of macro risks. But so long as such characteristics persist, it will remain a tough tape to fight aggressively. It wouldn't take much further upside to regenerate some overbought signals and restore the trader optimism that was relieved by the April chop, but neither technicals nor sentiment appear overcooked now. It's fair to point out that the recent pullback low failed to show the kind of indiscriminate purge and rise in fear that would classically cleanse the market and set up a high-energy, lasting new up leg. But bull markets don't always need a scary reset and the history of rallies after a 5-7% pullback shows the recovery rarely fails to reach at least 10%. Measured by sell-side attitudes, caution still prevails. Brian Belski, strategist at BMO, last week lifted his year-end S & P 500 target to a Street-high 5,600 . A lofty-seeming number, perhaps, but not even 6% up from where we sit. And the median strategist target is just 5,250 , 1% below Friday's close. While valuations are elevated at 20.7-times forward earnings, the S & P 500 P/E at 5,300 is slightly lower than it was on March 28 with the index at 5,250 because profit forecasts are up more. Not to deny that there are good reasons to keep expectations in check. The market itself has shown a bit more of a defensive tilt lately, with consumer cyclicals in particular flagging and transportation stocks notably lagging. The Citi U.S. Economic Surprise index has fallen into negative territory more deeply than any time since late 2022, meaning the macro data are slipping relative to increased forecasts. Retail sales for April were reported flat last week, too. 'Just the right amount of wrong' For now, the market overall is evidently viewing all this as "just the right amount of wrong," as the old Las Vegas casino ad said — a welcome deceleration in the economy that could help the Fed's disinflationary cause rather than the start of more pronounced weakness. Could well be, with lower-income spending softness offset by am urgent industrial and tech-hardware capital-spending boom and still-substantial fiscal support. Consumer activity outside the U.S. is improving too, another possible offset to American spending fatigue. But the "bad news is good news" dynamic among the economy, Fed expectations and the markets operates only under narrow and fleeting circumstances. Among the broader observations that are helping to sustain bullish feeling: There were two bear markets in the past four years, the S & P 500 is less than 11% higher than it was 28 months ago, and the current bull run is so far modest in both length and total appreciation compared to historical averages. It's fair to question the relevance of certain historical norms given all the ways in which the present cycle has been distinct and how frequently old macro-market relationships have failed to hold. There was a flash, forced recession in 2020 during which household finances improved, due to government support and forced saving. The Treasury yield curve has been inverted for more than 18 months with no sign of the recession one is supposed to foretell. Stocks never rallied as usual into the start of the Fed's tightening cycle but instead started a nasty downturn. And, quite remarkably, the stock market low of October 2022 occurred at an S & P 500 forward P/E above 15, with unemployment below 4% and in mid-economic expansion. And now the Fed has an easing bias, still with unemployment under 4%. Leuthold Group last week notes this has been one of three major market upswings that occurred in a "relatively mature" economic expansion. All lasted a couple years, give or take, beginning in 1966, 1998 and 2018 (the latter one halted by the Covid crash). If the current run were to approximate the prior two later-cycle recoveries, Leuthold says, the present rally would culminate late this year around the 5700 level for the S & P – up another 7-8%. Leuthold's chief investment officer Doug Ramsey says, "That's not our forecast, but, of late, these analogs have worked when we least expected them to."