The weight of the evidence suggests it continues to make sense to have long exposure to the stock market, despite widespread claims of a “bubble.” But it is a close call.
Here’s my logic.
4 Reasons to Stay Invested
1. No Bubble.
With AI stocks doing so well and the market at or near new highs, there’s widespread talk of a 1999-style bubble, on X and elsewhere. These concerns are unfounded. Ed Yardeni at Yardeni Research deflates the bubble talk with some valuation data.
He notes that the S&P 500 Information Technology and Communication Services combined forward P/E is just 23.2, not much above the overall S&P 500’s 21.2. In 1998-2000, this same combined forward P/E rose over 40.
Decoded, what’s going on here is that stocks – and in particular AI-related stocks – are posting robust gains in response to positive earnings momentum. They are not going up because of the kind of excessive tech enthusiasm and bullishness we saw in the late 1990s. This is an important distinction. In short, stocks are being driven by the “E” in P/E and not the “P.”
Yardeni likes to say this is not a FOMO market, but a FEMO market, for “fabulous earnings momentum.” For example, S&P 500 operating earnings per share rose 19.5% year over year in the first quarter, more than double the 8.7% long-run average, he notes. Analysts’ consensus estimates for S&P 500 earnings continue to climb. They now project 21.6% earnings growth in the second quarter, and 20.8% growth in the third quarter. “That’s FEMO at work,” says Yardeni.
To me, the “bubble talk” is not analysis worth heeding. Instead, it is part of the wall of worry that markets need to climb.
2. Insiders Remain Bullish.
During the week ending June 5, excluding one very large aberrational purchase, insiders bought $162 million worth of stock. That is more than double the $86 million in pre-war average weekly insider purchasing. Insider buying picked up sharply in the June 5 sell-off. Since insiders are “in the know,” this is bullish.
Note that my insider data may differ from other insider analysis you may see, because I exclude purchases by beneficial owners, or investors considered insiders because of large company holdings. Since most investors (around 80%) typically underperform the market, I see no reason to include them in insider analysis. So, I don’t. I only consider what actual company insiders are doing.
[text_ad]
3. Sentiment Is Negative (Which Is Bullish).
The Investors Intelligence Bull/Bear ratio last Tuesday came in at 2.5. On a de facto scale of around .7 to 5, this is negative enough to be a bullish signal, in the contrarian sense. I prefer contrarian investing because typically the crowd is wrong in the markets. A majority of clients (58%) at Charles Schwab, for instance, are bearish on U.S. stocks.
4. At Some Point, the Iran War Will End.
No one knows when. But given its unpopularity among voters heading into midterms, this seems like a likely outcome fairly soon.
...and 3 Reasons for Caution
All of this said, there are several risk factors to heed.
1. Sell the Trumpets.
Old-school logic around wars is that the end of a war is a negative for the markets. “Buy the cannons, sell the trumpets” is the time-tested axiom. This makes sense intuitively. The axiom reminds us that investors are typically too worried and cautious when war first breaks out. But then they are too jubilant and bullish when wars finally end.
2. Spooky Season on the Horizon.
I get that summer has yet to begin. But keep in mind that the worst-performing months of September and October are just around the corner. (Summer always goes by too fast!) Often, July and August can be quite volatile, too, both in response to quarterly earnings reports but also probably because some investors are already in trim mode ahead of September and October.
3. Inflation May be a Problem.
The oil futures strip suggests oil may remain $10 to $15 above pre-war levels at least through the end of 2027. This makes sense because shippers will stay cautious about mines in the Strait of Hormuz and the possible revival of hostilities. Plus, a lot of energy reserves and energy infrastructure need to be built up again.
Beyond this, the crop-disrupting El Niño is shaping up to be bad this year. This could boost agricultural commodity prices more than expected. As a policy, China has been cutting supply to ward off disinflation, and this feeds through into global price inflation.
Excessive inflation tends to be bad for both stock and bond prices. It also makes a Federal Open Market Committee (FOMC) rate hike more likely, another headwind for stocks. “We see the FOMC raising the federal funds rate in July, after pivoting to a tightening bias at its meeting this month,” says Yardeni. “That would be appropriate given the resilient economy, stable labor market, and rising inflation. Indeed, recent statements by various Fed officials suggest that a hawkish recalibration is underway.”
The bottom line: I am favoring the positives above, but the risk factors are not to be discounted. So, personally, I am reducing margin levels in my accounts significantly.
To learn more about how I’m trading, and how I use insider buying as a return-boosting market signal, subscribe to Cabot Insider Edge today. We’re currently offering a special promotion for new subscribers.
[author_ad]
