The fun-free party in stocks

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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.

Financial markets are having a party. But it feels like everyone’s invite got lost in the post. 

A week ago, the main US stocks benchmark, the S&P 500, cracked through to a record high, clawing back to the previous high-water mark struck two years ago. On Monday, it set a new even higher record. On Wednesday, well, you get the idea. We are on the cusp of a bull market — a 20 per cent ascent from recent lows. 

Normally, these moments are a time for celebration. Behold the majesty of capitalism at work! Admire its manifold rewards!

UBS Wealth Management is on board. In a note to clients, it bumped up its target for the index over this year to 5,000, up 3 per cent from its previous prediction, which has already been breached.

“While all-time highs often generate concerns that markets have peaked, our analysis shows that such worries are not typically warranted,” wrote Solita Marcelli, chief investment officer for the Americas. “The current rally has further potential.”

Historical precedents are promising. Data from the past 60 years show that the index sticks pretty close to typical patterns after striking an all-time high, gaining an average of 12 per cent over one year, 23 per cent over two and 39 per cent over three, UBS says. In addition, once a record level has been hit the market tends to cling to it, which means “the cost of waiting for a pullback can be quite high”.

But even the irrepressible optimists are getting twitchy. Veteran analyst Ed Yardeni, whose year-end target for the S&P is 5,400, from 4,890 or so now, is talking of a “melt-up” in tech stocks and pointing to signs of “irrational exuberance”. The usually reliably cheerful multi-asset team at HSBC is warning that “cracks are evident” and that chasing the market higher from here is perilous.

One reason for alarm is that the rally that has been in play since the final quarter of last year is simply too fast for comfort. But the biggest downer is that the record high is a bit fake. It is out on its own — the Russell 2000 index of smaller companies is still around 20 per cent below the peak it hit in 2021, and is down by 1.2 per cent so far this year. European stocks are up just 0.8 per cent.

Bond market gains have run out of steam. And overall S&P index gains are heavily skewed towards its biggest constituents — the clique of supersized tech stocks known as the Magnificent Seven.

So, just as we saw throughout 2023, the Mag7 — Apple, Amazon, Alphabet, Nvidia, Tesla, Meta and Microsoft — are doing the heavy lifting, most of them at least. By contrast, an equal-weighted version of the S&P that does not favour its biggest constituents is mildly weaker so far this year. In itself that is not necessarily a problem. It is certainly not a brand new phenomenon. But it does pose several challenges.

One is that, sure, we learnt this week that the US economy grew by 3.1 per cent last year, but we still do not really truly know whether it will achieve the miracle of dodging a serious recession. If a downturn does arrive, “these stocks will lead the way down”, says César Pérez Ruiz, chief investment officer at Pictet Wealth Management. “People will sell what they own,” he added. 

Another problem is that it seems too few of us in markets circles are film buffs. Luckily, David Kostin, chief US equity strategist at Goldman Sachs, is here to put us right. “Does anyone know where this name comes from? The Magnificent Seven?” he asked the 200 or so fund managers assembled at the bank’s plush London auditorium at an event earlier this month. Nods all round. Everyone knows it’s the name of the 1960 film featuring stars including Yul Brynner and Steve McQueen, who play the role of gun-toting heroes dispatched to protect a Mexican village from bandits. (OK, fine, I Googled it.)

The thing with that, though, as Kostin noted, is that “at the end of the movie, four of the seven are dead”. Cue some rather awkward chuckles from the audience. For this year, he said, “you can take the seven or you can take the field” — the other 493 companies in the index. “We’re going to take the field.” Kostin thinks the index is heading to 5,100 by the end of this year. But to assume that will happen quickly, in a straight line, and without some leg work from other blue-chip stocks is a dicey bet. 

Already, the share price of one of the Mag7, Tesla, has dropped more than 20 per cent since the end of last year, with this week’s drab fourth-quarter earnings justifying the caution. The drop has wiped a stonking $240bn off its market capitalisation, equivalent to the whole of Coca-Cola.

A barnstorming performance by other stocks in the Mag7 pack has disguised the damage, but this is concentration risk in action, and fund managers are keenly aware how quickly the apparently ebullient tone can unravel, especially with all the regulatory risk hovering around big tech. They may not have remembered that so many of the Magnificent Seven met with a sticky end in the classic film, but they are canny enough to know that a lot of innocent villagers got killed in the crossfire.

katie.martin@ft.com