U.S. Stocks at Record Highs: Will the Rally Continue?
Investors are questioning whether the dramatic run of U.S. stocks will continue or if a pause is on the horizon as the S&P 500 approaches a fresh record high. The hope for a halt in rising inflation has fueled the belief that the Federal Reserve will not raise interest rates further, leading to a rally that has seen the S&P 500 gain over 9% since late October. The index is now up 17% for the year and about 6% away from its January 2022 record closing high.
The ability to reach those levels in the coming weeks depends on investors’ confidence in the U.S. economy’s ability to achieve a “soft landing,” where the Federal Reserve brings down inflation without causing significant damage to growth. So far, the economy has shown resilience despite tighter monetary policy, although some employment and consumer demand indicators have weakened.
However, there are obstacles to consider, such as rising valuations and still-elevated Treasury yields. On the other hand, historical seasonal trends could support further gains.
Yung-Yu Ma, Chief Investment Officer at BMO Wealth Management, commented, “We have this balance right now between a lower inflation outlook and a better interest rate trajectory… juxtaposed against a slowing economy.”
Investor optimism in equities has grown in recent weeks as markets rebounded from a months-long drop. Active investment managers have increased their stock exposure to the highest level since August, according to the National Association of Active Investment Managers exposure index. Additionally, U.S. equity funds attracted approximately $9.33 billion in net inflows in the week ending November 15, marking the largest weekly net purchase since September 13.
One factor that has weighed on stocks in recent months is the steady rise in Treasury yields. However, these yields have quickly retreated, with the benchmark 10-year Treasury yield standing at 4.43% early Friday, down from a 16-year high above 5% last month.
Analysts at Ned Davis Research, who have recommended an overweight position in stocks, suggest further shifting into equities and away from bonds. The softer-than-expected consumer price data for October supports the belief that the Federal Reserve will not need to raise rates further.
Robert Pavlik, Senior Portfolio Manager at Dakota Wealth, highlighted that many investor concerns have diminished, including worries over better-than-expected third-quarter earnings results. Pavlik stated, “Both retail and institutional portfolio managers are going to realize that stocks are the best place to be between now and year-end.”
November and December historically offer strong returns for stocks. Since 1950, these months have posted the second- and third-biggest monthly returns, rising 1.5% and 1.4% on average, according to the Stock Trader’s Almanac.
Next week will present several tests for equities. Chip heavyweight Nvidia will report its quarterly results on Tuesday, marking the last report this earnings season from the “Magnificent Seven” megacap companies. Additionally, the health of the consumer-driven economy will come into view with Black Friday, the traditional start of U.S. holiday shopping.
One concern is the renewed climb in stocks’ valuations. The S&P 500 currently trades at 18.7 times forward 12-month earnings estimates, a two-month high and well above its long-term average of 15.6.
Jason Pride, Chief of Investment Strategy and Research at Glenmede, shared that his firm is underweight equities and has larger than normal allocations to cash and short-term fixed income. He stated, “Rates are still high enough, financial conditions are still tight enough that the near-term horizon… is troubling and probably doesn’t justify the high level of valuations.”
The recent surge in stocks also means that the bar for positive surprises is higher, according to Keith Lerner, Co-Chief Investment Officer at Truist Advisory Services. Lerner recommends adding to equity positions on pullbacks, stating, “It would be perfectly normal for stocks to take a breather here.”
In summary, while U.S. stocks have reached record highs, the continuation of the rally remains uncertain. The outcome will depend on various factors, including the Federal Reserve’s ability to manage inflation and the performance of the U.S. economy.
