Valuation Worries Build as Investors Run Out of Positive Catalysts
There isn’t much left to drive the market higher as we await second-quarter earnings.
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The indexes are starting the week with a mixed open as the major catalysts that drove the last three weeks of action have dried up and played out. The Iran deal is signed, the SpaceX (SPCX) IPO has happened, and new Fed Chair Kevin Warsh held his first meeting last Wednesday. There is some progress on the Iran negotiations being reported by Qatar and Pakistan as mediators, which has pushed oil lower again Monday morning, but bonds are weaker on inflation concerns following the hawkish Warsh meeting.
Last week finished with the S&P 500 up about 1% for its eleventh winning week in twelve. The Dow added roughly 1% and the Nasdaq advanced more than 2%. The Thursday chip-led rebound offset the Wednesday Fed selloff. The indexes are sitting near the highs but investors are struggling to find justifications to keep chasing them higher.
Valuation Concerns Are Building
The Wall Street Journal had a piece this weekend on the way major technology companies are using their appreciated stock as currency for acquisitions and capital raises. SpaceX bought Cursor for $60 billion in stock last week. Nvidia (NVDA) is offering investment-grade bonds for the first time in five years. Oracle’s (ORCL) capex guidance for fiscal 2027 jumped to $70 billion, with $40 billion in fresh capital needs, including significant equity issuance.
The pattern of companies with elevated valuations using their stock as currency is picking up steam across the AI group. The demand for capital is enormous, the cash needed to satisfy it is daunting, and the companies are using their stock prices to fund the growth. That is the kind of late-cycle behavior that occurs even when the underlying businesses are doing well. The stock issuance creates supply overhang for the issuing names, making the technical setup more vulnerable to disappointment than the indexes suggest.
Micron Technology (MU) reports fiscal Q3 results on Wednesday and the bar is set at perfection. The stock is trading around $1,151 and is up 831% over the past year. Micron’s market cap is now above $1 trillion. A beat that meets expectations may not be enough to push the stock higher. A miss or a soft guide would test the entire AI memory sector.
Catalyst Calendar Goes Quiet
After the Micron report and Thursday’s release of May Personal Consumption Expenditures, the list of catalysts becomes thin. The PCE is the Fed’s preferred inflation gauge and the core number is expected to rise from April, which is unhelpful for the dovish positioning that has built up since Friday. Thursday also brings the final Q1 GDP reading.
Then nothing major until second-quarter earnings start in mid-July. That is roughly three weeks of summer seasonality without a major catalyst to drive the indexes higher.
Following the hawkish Warsh dot plot, expectations for the first rate increase have moved forward to as soon as October. Bond yields rose Friday and the CME FedWatch tool is showing roughly 60% probability of at least one hike this year.
The combination of stretched valuations, narrowing breadth, a Fed that is preparing the ground for hikes, and a thin catalyst calendar produces the conditions for a period of consolidation or rotation. The indexes look strong on the surface, but the action under the surface has been weakening for two weeks. The rally has run hard on a favorable sequence of catalysts, and there is very little left to push it higher in the near term.
My Strategy
My game plan stays where it has been. My cash levels are high, trading is tight, and buying is selective. I am using shorter time frames, given the volatility, and doing some incremental positioning ahead of Q2 earnings where opportunities develop.
The indexes may run into overhead resistance here, and that creates a useful excuse for defensive action. There are a number of headwinds blowing through this market and I am proceeding with caution. The opportunity is in the rotational action and in individual stocks with their own catalysts rather than in chasing the index move. The path of least resistance over the next three weeks is likely sideways to lower until earnings season gives the market a new reason to move.
This is a market for stock pickers and risk managers rather than for momentum chasers and index buyers. The defensive posture has been working through the past three months and there is good reason to stick with it as recent catalysts are now exhausted.
At the time of publication, Rev Shark had no positions in any securities mentioned.
