Research.LeutholdGroup

With the S&P 500 snapping back to new highs, our team revisits the bubble debate. While valuations flash warning signs, speculation and momentum tell a more measured story.

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The market correction into the lows of early April was very painful, with the S&P 500 doing its usual job of camouflaging deeper declines in measures like the S&P MidCap 400 (-24.5%), S&P SmallCap 600 (-28.4%), and an index that’s become our poster-child for the frustrations of active managers—the Equal Weighted S&P 1500 Composite (-24.0%). 

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Bulls have more to cheer than the latest string of new highs. Another recession signal was issued in May by the Conference Board’s Index of LEI. Why cheer? In this decade, LEI has proven a superb contrary guide for stocks: Since 2020, LEI has been in recession mode 45% of the time, and SPX delivered +18% annualized during those months.

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We’ve had some internal debates as to whether the U.S. stock market qualifies as a bubble. Our tentative answer is “not yet.” Among the reasons: Speculative enthusiasm is not yet at truly manic levels, and the market’s 1-year advance is extremely muted vs. terminal blow-off phases in prior asset bubbles.  

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Since 1990, a monthly rebalanced, equally-weighted portfolio of the 50 stocks with the highest Price/Sales ratios has trailed both the cap-weighted and equal-weighted versions of the S&P 500 by about 3.0-3.5% per year on a total return basis. 

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Housing activity remains at very depressed levels, with 30-year mortgage rates near 7% keeping those with low-rate mortgages frozen in place, and those wishing to get into a home are frozen out. Qualifying income to buy a median-priced home is almost $105,000—up 122% from Feb-2020.

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Our S&P 500 Cyclical Sector Composite is one of three market bellwethers to join SPX at an all-time high. While technically bullish, the action generated a concurrent new peak in relative valuation that should temper the optimism of those heavily invested in traditional cyclical sectors. 

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SPX has become less representative of the broader U.S. stock market both in performance and valuation. In fact, the S&P 1500’s normalized P/E ratio has slipped below its long-term median, implying that returns near the long-term norm of +10% could be possible for the average stock in that index. 

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The SPX upturn to a new high has been confirmed by just three of the eight bellwethers we use to monitor breadth and leadership. Yet, we don’t view the uneven recoveries by the other eight as abnormal; our instincts are to wait a bit longer before classifying the laggards as yellow flags.

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“Sell In May” has been better advice historically than random chance suggests. Still, that seasonal pattern has so far been “Trumped” this year, with SPX +12% since late-Apr. Technicians tend to view new market highs as bullish, but that’s not always the case. The NYSE Daily A/D Line provides a clue as to whether the mid-year strength is apt to persist.

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There’s a strong argument that the internal peak of the bull market is behind us. The Equal-Weighted S&P 1500—featured prominently in this section this month—is still down 12% from its November 25th bull market peak.

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The sheer size of the equity market relative to U.S. GDP (roughly a two-to-one ratio) means that market swings—which always influence the economy—have taken on a more prominent role. 

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It turns out the “front-running” prophesied by bullish economic analysts has occurred in Prices, not New Orders. Such a backdrop is usually challenging for stocks. 

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There have been wild gyrations in the S&P 500 Cyclical/Defensive Ratio over the last year against a backdrop of historically high Cyclical valuation premiums. In other words, there’s no recession bet priced into the equity segments that should most reflect it.

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The NYSE Daily Advance/Decline Line hit a new high in May, which has traditionally been an “all-clear” for the stock market on a three- to six-month basis. Yet, the A/D Line’s strength doesn’t square with the rebound’s resumption of Large Cap leadership.

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We’re trying to draw obvious parallels between today’s bifurcated stock market and the late 1990s. But here, we do it solely to illustrate that the NYSE Daily Advance/Decline Line may be giving a too-rosy picture to market technicians—and the vastly greater number of closeted technicians. 

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Since the low in Oct. 2022, SPX is up 66%—typical for a bull market of this age; however, the broad-market stampede distinguishing a youthful bull never happened. Yet, those four years of futility were not in vain—the valuation profile for the average stock has improved markedly.

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We’re intrigued that Industrials was the first broad sector to eclipse its pre-correction high, and is still the only one to accomplished that. A market technician might argue that the divergent strength in such an economically sensitive segment is a bullish portent for the economy and stock market—but history doesn’t support that view.

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Stock-market dip buyers have again been handsomely rewarded, although it’s important to distinguish between words and action. Few (if any) being vocally bullish at April’s lows had told anyone to sell beforehand, and it’s likely their reward was more reputational than monetary.

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Markets are no longer hanging on every Fed whisper — fiscal policy has muscled into the spotlight. As investors navigate this new landscape, the old game of decoding central bank signals is giving way to something much clearer

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