new york
CNN
—
Since the pandemic, millions of Americans have seen their net worth soar as the stock market soars.
Wall Street's blockbuster earnings, the strongest consecutive year since the booming Clinton era of the late 1990s, boosted confidence and encouraged consumers to continue spending freely.
There are now growing concerns among some that things are getting out of hand and that the price tags of some stocks are disconnected from reality. The fear is that this could set the stage for a painful decline that could put the entire market at risk. economy.
“The stock market is forever pricing in nothing but blue skies and sunshine, which is very worrying,” Mark Zandi, chief economist at Moody's Analytics, told CNN in a phone interview. “Market valuations are so rich that they are on the verge of frothing,” he said of unsustainably high valuations.
Buoyed by the artificial intelligence boom and the Magnificent Seven Group of tech stocks, the Nasdaq soared 29% last year and is on track to rise an impressive 43% in 2023.
According to S&P Dow Jones Indices, the S&P 500 index gained a staggering $10 trillion in value last year. The market has pulled back slightly in recent weeks, but Zandi is concerned about a significant drop, perhaps more than 20%. Moody's economists said they haven't been this worried about market overvaluation since the late 1990s, when the dot-com bubble was inflating.
Zandi isn't worried about a collapse on the scale of the dot-com bubble, but he warns that today's market decline would seriously damage the U.S. economy. If Americans suddenly saw the value of their investment portfolios plummet, their fragile confidence would suffer. That would undermine both the ability and willingness to spend. That's no small thing in an economy where consumer spending remains the biggest driving force.
“High stock prices have played an important role in the success of the economy. It has caused a lot of spending. The wealth effect is very strong,” he said. “But if the stock market declines and that decline continues for an extended period of time, spending by high-income people will lose momentum. And that's a threat to the economy.”
Economists say the overall economic situation looks solid in early 2025. The number of layoffs is small. Inflation has subsided. Wages are growing faster than prices. Gas prices are being checked.
But David Kelly, chief global strategist at JPMorgan Asset Management, said the “danger” today is that valuations are high, making financial markets vulnerable to sudden declines. .
“I'm worried about asset bubbles,” Kelly told CNN. “Many castles in the sky have been built on the foundation of this very stable economy.”
Kelly specifically pointed to the high valuations of large-cap U.S. stocks and assets such as Bitcoin.
“There is a possibility that major revisions will be made at some stage in areas that are not connected to reality,” he said. “There are a lot of very frothy markets out there that could take a big hit. Investors have to think carefully about how much risk they're taking on.”
Of course, timing the stock market is notoriously difficult.
History shows that if a stock is overvalued, it's likely to stay that way for a while, or even go higher. Consider some Internet companies that never even generated revenue but continued to increase in value in the late 1990s before reality set in around 2000.
And betting on this runaway train in the stock market turns out to be expensive. Even the worst inflation crisis in 40 years and the most aggressive Federal Reserve since the days of Paul Volcker cannot end the ongoing bull market.
Still, cracks have recently appeared in the market, with investors paying attention to how dependent the entire market is on the Magnificent Seven: Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla.
Consider that the S&P 500's two-year total return (including dividends) is a very impressive 58%. But without Mag Seven, this would have fallen to just 24%, according to S&P Dow Jones Indices.
U.S. stocks ended 2024 on a weak note, and that volatility continued into Thursday, the first official trading day of 2025.
UBS recently warned clients that nearly all seven preconditions for a market bubble already exist.
“The problem with the bubble theory is that investors tend to lose 80% of their money when a bubble bursts,” Andrew Garthwaite, global equity strategist at UBS, said in a Dec. 18 report. He pointed out the collapse of past bubbles such as the Nifty. 50 stocks from Japan's dot-com bubble in the 1970s and late 1980s.
According to UBS, preconditions for an already existing bubble include a gap of at least 25 years since the last bubble, retail investor participation, and squeezed profits.
Bubbles “occur when there is a 'this time is different' narrative, usually tied to technological or market advantages, and we have both,” Garthwaite wrote.
The good news is that UBS claims the market is not yet in a “bubble” and that stock prices could “very easily” rise another 15% to 20% before clearly entering bubble territory. is.
Still, it's telling that the big Wall Street banks even use the B word.
Bubble or not, there are countless triggers that can cause a market downturn, given how high expectations have been set.
For example, there is a risk that one or more of the high-flying stocks driving this rally could stumble significantly, causing the rest of the group to fall. The bar has been set almost impossibly high for this group.
Meanwhile, lawmakers in Washington must ultimately find a way to defuse the debt ceiling time bomb, which was reinstated Thursday.
Investors are still trying to make sense of the incoming Trump administration's economic policies, which call for lower taxes, higher tariffs, deregulation and mass deportations.
It's easy to see how announcements of tariffs and dramatic immigration crackdowns would unsettle investors, who are on high alert for inflation.
But the first signs of trouble may be in the bond market.
Ed Yardeni, president of Yardeni Research, an investment advisory firm, warns that the stock market will be “scared” if the bond market decline pushes the 10-year Treasury yield closer to 5%.
Yardeni, who coined the term “bond market vigilante” in the early 1980s, said investors are watching closely to see whether Congressional Republicans can address growing concerns about the federal budget deficit.
“If they can't get their act together and just agree to a tax cut, the bond market will be in turmoil,” he said.
Given the recent rally, it's no surprise that some investors are considering a possible reversal.
Of course, it's also possible that the market will stay sideways rather than go down. That would buy time for corporate profits to catch up with high valuations.
Yardeni doesn't see the risk of a bear market, typically defined as a 20% decline from historical highs, as a recession doesn't appear to be imminent.
However, they are asking for a 10% to 15% correction.
“We don't see it as a reason to panic, we see it as a buying opportunity. That doesn't mean it's not unpleasant,” Yardeni said.
Christina Hooper, chief global market strategist at Invesco, said long-term investors should avoid market declines as the overall environment is likely to be positive for equities and risk assets.
“It's irrelevant in the grand scheme of things,” Hooper said. “While we may see a pullback, it will be temporary and probably healthy, setting the stock market up for the next rally.”
