Some market gurus are beginning to worry that Wall Street’s summer rally is starting to run out of steam, after stocks quickly went from oversold to overbought.
Gene Goldman, chief investment officer of Cetera Financial Group, explained that stocks are likely heading for a pullback, even though the economy is in better shape than many Americans think.
“There has been a lot of good news, but the market needs a little break. We’ve gone a little too fast, too fast right now,” Goldman said in a phone call with MarketWatch.
To back up that view, he pointed to a handful of reasons why Friday’s stock slide could continue into next week, and possibly longer – although he remains bullish on stocks longer term.
Defensive sectors back in fashion
Cyclical sectors outperformed, with equities rebounding in July and early August. But that trend seemed to be coming to an end this week as defensive sectors regained the lead.
“A sign that investors are getting nervous is that cyclical sectors are underperforming defensive sectors, and we’re starting to see that now,” Goldman said.
Over the past week, consumer staples and utilities stocks have been the two best performers among the 11 sectors of the S&P 500. As a result, the SPDR Consumer Staples Select Sector fund
XLP,
an exchange-traded fund that tracks the sector, rose 1.9%, while the Utilities Select Sector SPDR Fund
41
gained 1.3%.
In contrast, the two worst performing sectors were Materials and Communication Services, both cyclical sectors. SPDR Materials Select Sector Fund
XLB,
was down 2.4% for the week, while the communications services sector SPDR fund
XLC,
lose 3.1%.
Bond yields rise
Rising bond yields are another sign that the equity rally may be about to turn, Goldman said.
Higher Treasury yields can pose a problem for stocks because they make bonds a more attractive investment in comparison. Stocks and bonds often moved in unison at the start of the year as expectations of Federal Reserve monetary policy tightening rattled both assets.
But that dynamic seems to have changed in August. Treasury yields rose earlier this month and started to rise before equities hit a rough patch over the weekend.
The return on the 10-year treasury bill
TMUBMUSD10Y,
has risen 35 basis points since August 1, and it has climbed 14 basis points since Monday to 2.897%.
Bond yields rise as prices fall, and Goldman and others on Wall Street are now waiting to see if stocks will follow bond prices lower.
See: Fed’s Bullard says he’s inclined to back 0.75 percentage point hike in September
So is the dollar
Rising Treasury yields and slowing inflation helped push the US dollar higher, creating another potential headwind for equities. The ICE US Dollar Index
DXY,
an indicator of dollar strength against a basket of rivals, rose above 108 on Friday, hitting its highest level in a month.
See: The US Dollar is on fire and slicing through key technical levels “like a hot knife through butter”
A strong dollar is usually associated with weaker stocks because it erodes the foreign earnings of US multinationals by causing them to lose their value in US dollars.
Cryptocurrencies are falling
Cryptocurrencies like bitcoin
BTCUSD,
and ethereal
ETHUSD,
lately, they’ve been trading almost at par with stocks, especially megacap tech stocks like Meta Platforms Inc.
META,
and Netflix Inc.
NFLX,
But the crypto sold off sharply on Friday, leading some to wonder if stocks could be next.
“Another sign of a market break is crypto weakness. This is a clear sign of a risk trend in the market,” Goldman said.
Bitcoin fell around 9.5% on Friday, while Ethereum, the second most popular cryptocurrency, lost around 10%, according to CoinDesk.
Stock valuations are out of sync with corporate earnings
Another reason to wonder about the rally in equities is that there seems to be a mismatch between equity valuations and corporate earnings expectations.
As Goldman pointed out, the S&P 500 price-to-earnings ratio rebounded to 18.6 times forward earnings, from a low of 15.5 in mid-June. At the same time, expectations for corporate earnings for these same companies over the next 12 months have fallen from $238 to $230.
“Stocks rise on falling earnings estimates,” Goldman said.
Goldman isn’t alone in worrying about rising stock valuations. In a recent note to bank clients, Scott Chronert, Citigroup’s U.S. equity strategist, said the risk of lower corporate earnings heading into 2023 could create a “valuation headwind” for investors. shares.
“We would say tactically selling more force is warranted,” he said.
US stocks fell on Friday, along with the S&P 500
SPX,
down 55.26 points, or 1.3%, to 4,228.48, while the Nasdaq Composite
COMP,
lost 260.13 points, or 2%, to 12,705.22. The Dow Jones Industrial Average
DJIA,
fell 292.30 points, or 0.9%, to 33,706.74.
Friday’s losses for stocks pushed all three major benchmarks into the red for the week, marking the S&P 500 and Nasdaq’s first weekly decline in a month.
Highlights of next week’s economic data calendar are set to arrive on Friday, when Federal Reserve Chairman Jerome Powell is due to deliver his annual address at the central bank’s economic symposium in Jackson Hole, Wyo. The Fed’s commitment to the fight against inflation.
See: Powell to tell Jackson Hole recession won’t stop Fed’s fight against high inflation
In addition to hearing from Powell, investors will receive an update on the pace of inflation via the Personal Consumption Expenditure Index, the Fed’s preferred gauge of price pressures. The closely watched University of Michigan confidence survey, which includes readings on consumer inflation expectations, is also on Friday’s schedule.