Is the bull market starting to slow?

Key Concepts

• Market Bubble/Peak
• Bull Market
• Pullback/Correction
• Underlying Fundamentals
• S&P 500
• Concentration Risk
• "Max 7" Stocks
• Earnings Growth
• Capex (Capital Expenditures)
• Debt Markets/Bond Market
• Portfolio Hygiene
• Rebalancing
• Global Diversification
• Appreciated Securities
• K-Shaped Economy/Market
• Higher Income Consumer
• Lower Income Consumer
• Interest Rates
• Rate Cuts
• Federal Reserve (Fed)
• Inflation
• Tariffs
• Fed Credibility
• Inflation Expectations

Market Outlook and Investor Concerns

The discussion addresses concerns about a potential market bubble and whether the bull market has peaked. While a pullback is considered normal, especially after the energy deployed since April lows, the underlying fundamentals of the market remain strong. This is evidenced by strong company earnings, with approximately two-thirds of the S&P 500 having reported, showing double-digit bottom-line earnings growth. A pullback is seen as constructive, allowing markets to reset after running ahead of themselves.

Concentration Risk and Earnings Drivers

A key point of discussion is the concentration risk within the S&P 500, where six stocks have driven half of the market's gains, leading to 36 record highs. However, it's emphasized that these same companies are also driving the bulk of earnings and profitability. This situation is contrasted with the late 1990s, with the current environment being different because real companies are generating real revenues from real businesses. These companies are capacity-constrained, leading to significant capital expenditures (capex). A concern is raised about how these endeavors are being funded, with some now occurring in debt markets rather than through cash flow. While concentration is present, there were signs of broadening out in other companies and sectors, such as industrial manufacturing and materials, which were also showing double-digit earnings growth.

Funding Strategies and Systemic Risk

The reliance of "Max 7" players on debt markets and the bond market for funding is a point of concern. The risk of these companies and their funders becoming too intertwined, creating a "too big to fail" scenario, is being watched closely. While these companies initially had strong balance sheets and were trying to lever responsibly, the potential for over-leveraging and systemic risk is a significant consideration.

Investment Strategies and Portfolio Management

Regarding investor strategy, the advice is to rebalance portfolios throughout the year, a practice referred to as "portfolio hygiene." Global diversification is also recommended, as US markets have underperformed some global markets. For clients with year-end or early-year bonuses, a pullback presents an opportunity to deploy cash. Conversely, clients with significant year-to-date gains are advised to trim back and rebalance. The use of appreciated securities for year-end gifting to charities is also highlighted as a beneficial strategy.

The K-Shaped Economy and Consumer Behavior

The conversation links the K-shaped stock market to a K-shaped economy, driven by higher-income consumers. This trend is a cause for concern, as it could impact overall economic growth. Strain is evident on the lower end of the K-shaped spectrum, both economically and demographically. Frontline consumer companies are reporting that consumers are struggling with higher prices compared to five or six years ago. Autos, homes, and education are expensive, making it difficult for lower-income consumers. These consumers are value-conscious and making choices, such as opting for local travel or diverting spending from certain items to others. In contrast, the spending of higher-income consumers is more tied to housing values and stock market performance, rather than employment concerns. Despite potential pullbacks, the top tier's net income and values are expected to have grown substantially.

Bank of America's Outlook and Interest Rate Expectations

A discussion with Bank of America CEO Brian Moynihan revealed that their medium-term outlook for 12% earnings growth is contingent on an interest rate environment of around 3%. This suggests an expectation of rate cuts. While the Fed Chair has pushed back on aggressive rate cut expectations, the market has been right to pull back some of the odds for rate cuts in the first half of next year. This is attributed to the Fed's renewed focus on inflation and the potential impact of tariffs. The Fed cannot cut rates too quickly due to sticky inflation above their target. The expectation is that the Fed will eventually reach around 3%, which is where the market has priced it, as this is seen as a level where policy is no longer restrictive. However, the Fed is expected to proceed slowly, potentially skipping December before making its next move. Bank of America's investor day is noted as unusual, possibly driven by investor pressure due to the stock's performance relative to investment banks.

Federal Reserve Credibility and Inflation Expectations

A significant concern raised is the potential long-term damage to the Federal Reserve's credibility due to attacks from the administration. Surveys indicate that businesses no longer perceive the Fed's inflation target as 2%, but rather 2.5%. This shift is seen as a blow to the Fed's credibility, as central banks typically maintain a firm stance on their targets. Consumer surveys also show elevated one-year inflation expectations, suggesting a lack of confidence in the Fed's ability to bring inflation down quickly. This indicates that the attacks on the Fed have had a tangible effect on its perceived effectiveness and trustworthiness.