By Lance Roberts

Even one of the “always bullish” media outlets took notice, which is notable.

As Brian Sozzi notes in his article, we may be at the “this is nuts” stage of market exuberance. Such usually coincides with Wall Street analysts stretching to “justify” why paying premiums for companies is “worth it.”

We Can’t All Be Winners

Of course, that is the quintessential underpinning for a market that has reached the “this is nuts” stage. There is little doubt about Nvidia’s earnings and revenue growth rates. However, to maintain that growth pace indefinitely, particularly at 32x price-to-sales, means others like AMD and Intel must lose market share.

Again, if you don’t understand why “this is nuts,” read the linked article above.

However, in the short term, this doesn’t mean the market can’t keep increasing those premiums even further. As Brian concluded in his article:

“Nothing says ‘investing bubble’ like unbridled confidence. It’s that feeling that whatever stock you buy — at whatever price and at whatever time — will only go up forever. This makes you feel like an investing genius and inclined to take on more risk.”

Looking at some current internals tells us that Brian may be correct.

“This Is Nuts” Type Of Exuberance

In momentum-driven markets, exuberance and greed can take speculative actions to increasingly further extremes. As markets continue to ratchet new all-time highs, the media drives additional hype by producing commentary like the following.

“Going back to 1954, markets are always higher one year later – the only exception was 2007.”

That is a correct statement. When markets hit all-time highs, they are usually higher 12 months later due to the underlying momentum of the market. But therein lies the rub: what happened next? The table below from Warren Pies tells the tale.

As shown, markets were higher 12 months after new highs were made. However, a lot of money was lost during the next bear market or correction. Except for only four periods, those bear markets occurred within the next 24 to 48 months. Most gains from the previous highs were lost in the subsequent downturn.

Unsurprisingly, investing in the market is not a “risk-free” adventure. While there are many opportunities to make money, there is also a history of wealth devastation. Therefore, understanding the environment you are investing in can help avoid potential capital destruction.

From a technical perspective, markets are exceedingly overbought as investors have rushed back into equities following the correction in 2022. The composite index below comprises nine indicators measured using weekly data. That index is now at levels that have denoted short-term market peaks.

Unsurprisingly, speculative money is chasing the Mega-cap growth and technology stocks. The volume of call options on those stocks is at levels that have previously preceded more significant corrections.

Unsurprisingly, with the surge in market prices, investor confidence has surged along with their allocation to equities. The most recent Schwab Survey of bullish sentiment suggests the same.

“More than half of traders have a bullish outlook for the first quarter – the highest level of bullishness since 2021“

Yes, quite simply, “This is nuts.”

Market Measures Advise Caution

For example, the last time bullish sentiment was this extreme was in late 2021. Even though the market eventually rallied to all-time highs, it was 2-years before investors got back to even.

Furthermore, the compression of volatility remains a critical near-term concern. While low levels of volatility have become increasingly common since the financial crisis due to the suppression of interest rates and a flood of liquidity, the lack of volatility provides the “fuel” for a market correction.

Combining excessive bullish sentiment and low volatility into a single indicator shows that previous levels were warnings to more bullish investors. Interestingly, Fed rate cuts cause excess sentiment to unwind. This is because rate cuts have historically coincided with financial events and recessions.

While none of this should be surprising, given the current market momentum and bullish psychology, the over-confidence of investors in their decision-making has always had less than desirable outcomes.

No. The markets likely will not crash tomorrow or in the next few months. However, sentiment has reached the “this is nuts” stage. For us, as portfolio managers, such has always been an excellent time to start laying the groundwork to protect our gains.

“Lean on your investing experience and all its wrinkles.” – Brian Sozzi