2 Major Issues Loom as the Market Reaches Historic Levels of Lopsidedness
The market is about to encounter a serious test of its bullish resolve.
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With the end of the Fourth of July week, the market action is about to encounter a more serious test of its bullish resolve. Big-cap technology stocks have been giddy with delight as a handful of AI-related names gallop higher and widen the gulf over the rest of the market.
The action is unsustainable, but it has persisted much longer and gone much further than nearly all market pundits thought possible.
There are two issues brewing that may finally change the trajectory of the market.
The first is earnings season. Big banks kick things off on Friday when JPMorgan Chase JPM, Citigroup C, and Wells Fargo WFC report. We then move into the meat of the S&P 500 over the next two weeks. The big question is whether the very extended big-cap technology names that have been steadily hitting new highs can produce strong enough earnings to avoid a "sell-the-news" response.
These large-cap stocks are not cheap, but they have been safe havens for investors because their relative strength creates the illusion of safety. Valuation has not mattered even though names such as Apple AAPL will likely have single-digit growth and a P/E ratio of 34. The promise of AI has rendered actual numbers rather meaningless at this point.
The second issue the market will confront is a growing realization that the economy is slowing down. So far, economic slowing and a drop in jobs have been seen as a market positive because it is anti-inflationary. It is now widely expected that the Fed will cut rates by a quarter point in September.
A more dovish Fed is being discounted as the S&P 500 and Nasdaq 100 hit new all-time highs, but by the time the central bank actually does cut rates, it may be anti-climatic. Some pundits believe that the market is likely to top when the much-anticipated rate cuts actually occur.
The problem with an economic slowdown is that while it may help to produce lower interest rates, once a contraction starts to take hold, it can easily gain momentum and have severe consequences, such as people losing jobs, sales declines, and profit margins being squeezed. A weak economy has not been a market concern for a long time, but there are signs that it could start to have a negative impact on sentiment.
There are a number of other issues the market must also navigate, such as the impact of the surprise victory of leftist political forces in France and a chaotic election in the U.S. The market has not had much of a reaction so far to the Joe Biden drama, but it is a source of instability that could have some effect down the road.
Currently, the bulls are celebrating a historically narrow and distorted stock market, but there are no signs of rotational action that are badly needed to restore some level of logic. As the old saying goes, "the market can remain irrational longer than you can remain solvent."
At the time of publication, Rev Shark had no positions in any securities mentioned.
