Research.LeutholdGroup

Is the U.S. stock market a bubble? As we answer elsewhere in this section, no. It is only priced like one.

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The wealth effect created by rising stock prices puts the Fed in a bind. The market recovery since late 2022 has stimulated receipts from capital gains taxes, and should continue to do so for the next several months. But this recovery in tax receipts has still left the 12-month federal deficit at an astounding 6.1% of GDP, about 2 1/2 points wider than at its best level of the recovery in mid-2022.

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We don’t contend that the 3.3% YoY gain in CPI totally understates today’s inflation rate; however, small measurement errors add up over time. Only a government economist could believe that the CPI’s 21% increase since January 2020 captures the true rise in Americans’ cost of living.

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Despite monthly statistical quirks, the clear trend in the labor market is one of weakening. Somehow, though, the “tight labor market” narrative promulgated by economic bulls has yet to die off, with just enough oddball evidence surfacing every few weeks to keep it alive. Contrary to the storyline, certain employment measures have followed paths that are weaker than the lead-up to any previous recession.

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The S&P 500 is up about 56% in the last 21 months, a figure that’s right in line with its average gain at the same point of all major market advances since 1957. However, this move should be considered substantially better than average when we consider the “late-cycle” nature of the monetary and economic backdrop that’s accompanied it.

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We do think that a September rate cut—the first of many—now looks likely. But the aftermath of any cut might not be what traders are conditioned to expect. Subsequent to the tightening cycles of 1999-2000 and 2006-2007, the initial rate cuts provided timely excuses to dump stocks—as did most of the cuts that followed.

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Question: Would you characterize the current U.S. stock market as a bubble?

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The YTD gap between the cap-weighted and equal-weighted S&P 500 is a shocking 13%. The silver lining of this massive underperformance is that valuations for most of the index’s constituents now look pretty cheap relative to the S&P 500 itself.

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The main reason the “average stock” looks relatively cheap is that the cap-weighted S&P 500 has moved to within 2% of the valuation levels reached at its January 2022 bull market top. Still, three of the four measures of the median S&P 500 stock shown here reside in their tenth deciles.

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The last five weeks in the stock market have had a “Groundhog Day” feel to them: S&P 500 and NASDAQ 100 up sharply on most days, while the DJIA and Russell 2000 trade flat- to down.

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In retrospect, a good hint that the first half of 2024 might be a special one for the stock market came on the year’s first day of trading, when the percentage of S&P 500 stocks trading above their 50-day moving averages broke above 90%.

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Confidence in the economic soft-landing scenario probably peaked in early April. The past two months have brought a stream of disappointing data, dragging the Citi U.S. Economic Surprise Index below zero for the first time since early 2023. No problem… stock investors have shifted seamlessly into their “bad news is good news” mode.

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The S&P 500 is like a beach ball one tries to keep underwater. Whether that particular sphere could also be described as a bubble is open to question.

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The 10-Yr./3-Mo. Treasury spread and the Near-Term Forward Spread both inverted in November 2022. Unless the peak of the current economic expansion is back-dated to March (very unlikely), the lag time between the inversion and any near-term recession will be the longest ever for a successful inversion signal.

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The contraction in full-time jobs completely explains this year’s sudden collapse in the growth rate of real personal disposable income. The rate has disintegrated from 4% at year-end 2023 to just 0.9% in April, and matches that which prevailed on the eve of the 1980 recession.

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Small Cap investing remains an exercise in futility, with the Russell 2000 already trailing the S&P 500 by more than 10% through early June. Even Technology stocks can’t escape the curse.

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Over the years, some of the best thematic plays in our Select Industries equity portfolio have been those that—at least initially—seemed to make the least “economic sense.” For example, who would have bet on Homebuilding stocks to shrug off a four-point spike in the 30-year mortgage rate over the last two-and-a-half years? Not many.

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The stock market picture at the June 5th SPX high was not as cohesive as that of late March. Just two of our eight bellwethers—Dow Jones Transports and Dow Jones Utilities—had failed to confirm the new market high at the end of March. At the high on June 5th, however, the list of laggards expanded to include the Russell 2000, S&P 500 Cyclical Sector Composite, and the S&P 500 Equal Weighted Index.

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While “divergences” between two market indexes are readily apparent on a chart, they are not so easily quantified. And evaluating whether such disparate action has any forecasting ability is even more difficult.

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Our studies of the S&P 500’s co-movements with the A/D Line and Financials sector confirmed our belief that these bellwethers are valuable ones. It’s certainly the type of result we like to publish. (“Hey look, our gut instincts were correct all along.”)

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