- The lofty valuations of big technology companies at the forefront of the stock market’s rally could short-circuit the next all-time high, according to Doug Ramsey, the chief investment officer at The Leuthold Group.
- He showed two historical analogs that saw stocks came within 2% of their record high before rolling over hard.
- Beyond tech valuations, Ramsey flagged the relatively weak performance of sectors that traditionally lead when the economy is recovering from recessions.
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Despite the extraordinary turbulence that investors have endured this year, not everyone will be breathing a huge sigh of relief if stocks break record highs in short order.
You can count Doug Ramsey, the chief investment officer at The Leuthold Group, among that cohort. With the S&P 500 now within 1% of its Feb. 19 high, Ramsey is flagging a number of reasons why the next record-setting close may not entirely be cause for celebration.
For starters, he cites the undisputed champions of this move higher: big technology stocks that were perfectly positioned to sell their products and services to a physically distanced world. But even this fundamental demand driver behind their performance is not enough to shroud how expensive they have become, and how reliant the broader market has become on their fate.
“Given still-high valuations for the blue chips and increasingly frothy sentiment, we think any break above that high will be underwhelming, if not a potentially historic ‘trap,'” Ramsey said in a recent note to clients.
He found two historical instances when stocks rolled over hard after coming within 2% of their record high.
The first was in July 1957, when the S&P 500 came within striking distance of the record it had ascended to almost a year prior.
The second occurrence took place in 2000, when the index tried for a new high six months after its March high. What followed was the infamous dot-com crash.
The Leuthold Group
Astute students of market history would be quick to point out that tech stocks today, unlike in 2000, are delivering the goods to shareholders in terms of profits. Surely, strong earnings and healthy balance sheets justify at least part of their eye-popping valuations.
But for Ramsey, these facts alone do not cancel out the other reasons why stock-market investors should proceed with caution.
Concerns besides big-tech valuations
One technical indicator that is flashing a warning signal on his radar is breadth thrust. It’s a gauge of the market’s momentum that is expressed via a 10-day moving average of the ratio of rising stocks versus total stocks on an exchange.
This technical signal fired with a lag after the March sell-off because many of the cyclical stocks that usually lead the market out of recessions actually lagged in the early stages of this recovery. It was not until mid-May that they briefly caught on fire and triggered the breadth-thrust signal.
As the chart below shows, the Russell 2000 — closely tied to fluctuations in the domestic economy due to its preponderance of smaller companies — is abnormally weak compared to other confirmations of this signal since 1979.
The Leuthold GroupOn one hand, this serves as further proof of the sheer dominance of high-growth tech stocks, and it showcases the winner-take-all status that they enjoy.
However, Ramsey remains concerned about the message that the non-tech parts of the market are sending. Traditional cyclical groups that normally jump higher are just not displaying the same vim this time. Those groups include S&P Financials and the Dow Jones Transports.
By contrast, big-tech stocks have become so richly valued that their future upside could be challenging, even as sectors that were decimated by the pandemic start to normalize. And therein lies the trap Ramsey is warning about.