war in the middle east. War in Ukraine. Rise in crude oil prices. Inflation remains above 3% and mortgage interest rates are above 6%. Donald Trump could be re-elected, and a trade war with China could follow. Stock market investors seem to have a lot to worry about. But so far this year, they have shaken off their fears. The S&P 500 index posted its best first-quarter performance since 2019, rising more than 10%. And this comes on the heels of a strong 2023, when the S&P rose 24%.
Understandably, this bull market has some market participants concerned. Permabear's Jeremy Grantham, who appears to have never experienced a market bull run, warned that the market is at “illogical and dangerous” levels. So much of the recent boom has been driven by tech stocks, particularly AI-related stocks, that some commentators have drawn similarities to the stock market bubble of the late 1990s, known as the dot-com boom. . Even more restrained critics argue that S&P's performance has been driven by big gains in a relatively small number of high-value stocks, so if those stocks soar, the market risks plummeting. As J.P. Morgan investment strategists recently put it, extreme market concentration poses “a clear and present risk to the stock market in 2024.”
Given how much the stock has risen in just the past six months, it's understandable that there is some skepticism about the sustainability of this rally. And predictions about bubble bursts are exciting and make headlines. Naturally, when the stock market skyrockets based on the fortunes of a few hot stocks, many people get very anxious. However, sometimes stock prices soar for a reason. The key is to separate the signal from the noise.
The underlying reality is that this rally is driven primarily by economic fundamentals such as a continued strong U.S. economy, corporate margin and profit growth, and even some optimism about future rate cuts by the Federal Reserve. This means that it is brought about byInvestors do have to contend with considerable uncertainty, but to use the term bubble It is simply a misconception to describe this market.
Consider the problem of concentration. Indeed, much of last year's market gains were driven by the so-called Magnificent Seven stocks: Apple, Microsoft, Meta, Amazon, Alphabet, Nvidia, and Tesla. And depending on what criteria you use, the concentration at the top of the market is high even by historical standards. (For example, the combined market capitalization of the top 10 companies in the S&P 500 accounts for about one-third of the index's total value.) However, compared to other major stock markets, the American stock market currently has a Not top class. All countries except Japan. Moreover, as Goldman Sachs Research senior strategist Ben Snyder pointed out in a recent report, concentration is the norm rather than the exception in bull markets. Some of his rallies in 1973 and 2000 ended very poorly, but most did not.
Market concentration also reflects concentration in the U.S. economy, with an increasingly fierce winner-take-all competition, especially in the high-tech industry, where dominant players earn huge profits and enjoy very high returns. can. investment capital. For example, chipmaker Nvidia controls more than 95% of the specialized AI chip market, which is why the company made $33 billion in operating profit in its most recent fiscal year, up 681% year over year. It helps explain. Similarly, Alphabet, Meta, and Amazon together suck up more than two-thirds of global digital ad spending.
These companies' high valuations, in turn, reflect their large profits and prospects for continued revenue growth. Let's look at NVIDIA again. The company's stock price has increased by 214% over the past year. But over the same period, the company's forward price-to-earnings ratio (a simple measure of valuation) actually rose. fellThis is because profit growth is outpacing stock price growth. According to Snyder's calculations, the top 10 stocks in the S&P 500 have a combined forward price/earnings ratio of about 25 times. This is relatively expensive, but far from bubble territory. As Mr. Snyder points out, today's top 10 stocks have far lower price-to-earnings ratios than the top 10 in 2000, and their companies have much higher profits.
Plus, not everything about The Magnificent Seven is so great. Alphabet's stock has performed roughly in line with the market this year. Meanwhile, Apple's stock price has fallen more than 10% since the beginning of the year due to weak business results and concerns about antitrust lawsuits brought against the company by the U.S. government. And Tesla's stock price has fallen by more than 30%, a steep drop as investors worry about slowing sales growth and increased competition from China. Mag Seven has become the Big Four. Still, the stock market remains strong. This suggests that concerns about the dangers of market concentration are overblown.
In addition, the stock market's rise this year has further expanded. All sectors of the market rose in the first quarter, except real estate. In fact, if you look at all the stocks in the S&P 500 except for the Magnificent Seven, they're up an average of 8% in the first quarter, which is a much better return.
As the declines in Apple and Tesla stocks show, investors aren't simply buying across the board. In fact, they differentiate companies based on their earnings prospects, a behavior that is generally not characteristic of bubbles. There are also few signs of other bubbles. Individual and institutional investors in the United States still hold trillions of dollars in money market funds rather than in the stock market (thanks to the high interest rates that funds currently offer). And instead of trying to cash out their stock prices by issuing more shares, companies keep buying back stock.
Another indicator is that the initial public offering market has remained relatively calm, despite some high-profile offerings such as Reddit and, of course, Donald Trump's Meme Inc. This is fundamentally different from what is typically seen in active markets. For example, in 1999 he had 476 IPOs. This year, we are expecting about 120 people.
There's no question that current stock market valuations are high. A number of factors could also derail the market rally, including soaring oil prices and lower-than-expected profits. The most obvious concern is that investors are assuming the Fed will cut interest rates this year, even as inflation continues to rise above 3%, still well above the Fed's 2% target. This may be too optimistic. If these rate cuts don't materialize, stocks could take a hit (as they did yesterday when markets fell after the government reported that inflation last month was higher than expected). But it's not the bursting of the bubble. Because no bubble will burst. Ignore the permabear noise since the signal is at the fundamental.
