Chasing an Overheated and Narrow Stock Market Will Lead to Disaster

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Brian Evans and Alex Harring of CNBC report the S&P 500 breaks six-day win streak on Friday, but still notches best week since March:

Stocks slipped on Friday as Wall Street closed out a huge week in which investors received a pause on rate hikes from the Federal Reserve, plus encouraging inflation data.

The S&P 500

ticked down 0.37% to close at 4,409.59, while the Dow Jones Industrial Average slipped 108.94 points, or 0.32%, to close at 34,299.12. The Nasdaq Composite

lost 0.68% to finish the session at 13,689.57.

Here are the major market milestones on the week:

  • The S&P 500 is up 2.6% on the week, its best performance since March.
  • It’s the S&P 500′s fifth positive week in a row, the first such streak since November 2021.
  • The benchmark is now up more than 26% from its bear market low.
  • The Nasdaq Composite is up about 3.3% on the week, its best week since March.
  • The Nasdaq is up eight weeks in a row, its best winning streak since 2019.
  • Both the Nasdaq and S&P 500 were up six days in a row through Thursday.
  • The Dow Jones Industrial Average was up nearly 1.3% for the week, its third positive week in a row.
  • The S&P 500 and Nasdaq have hit their highest levels since April 2022.

The Federal Reserve delivered what investors wanted this week when the central bank left rates unchanged Wednesday after 10 consecutive hikes. While the Fed signaled that two more rate increases were coming this year, many traders and economists on Wall Street believe the Fed could be nearly done. Earlier in the week, the May consumer price index came in at the lowest in two years.

Adobe added 0.9% after beating results and issuing upbeat guidance, the latest tech stock to rally. AI darling Nvidia gained 10% this week, adding to its 192% surge this year. Microsoft added 4.7% this week and hit a record Thursday. Tech shares were the hardest hit initially when the Fed embarked on its rate-hiking campaign.

“Wall Street remains upbeat that the AI wave won’t be going away anytime soon and that investors will prefer US stocks as we see diverging central bank policies worldwide,” said Ed Moya, senior market analyst at Oanda. “This stock market rally seems a bit overextended but too much money remains on the sidelines, which means if the AI trade remains intact, this winning streak for the S&P 500 can continue.”

Friday brought more good news on the inflation and economic front. Consumer inflation expectations fell in June, with one-year assumptions for price pressures declining to 3.3% from 4.2% in May. The headline reading from the University of Michigan Survey of Consumers came in at 63.9, higher than estimates of 60.2 from Dow Jones.

Friday’s session saw choppy moves across the stock market as stock options, index futures and index future option contracts.

Friday also marks the final trading day before a long weekend, with the market closed Monday in observation of Juneteenth.

Lewis Krauskopf, Saqib Iqbal Ahmed and David Randall of Reuters also report on Wall Street's week ahead and how investor skepticism turns to optimism as US stock rally rolls on:

A few months ago, most investors feared having too much exposure to equities. Now many are worried they may not have enough.

The 15% year-to-date rally in the S&P 500 (SPX) is pulling once doubtful investors back into the market. Many who had whittled down stock holdings during 2022's painful decline are shifting gears.

The National Association of Active Investment Managers' exposure index last week hit its highest level since late 2021, while cash levels among global fund managers surveyed this month by Bank of America fell to their lowest point since January 2022.

Positioning among discretionary investors, a cohort that includes fund managers to individual investors, moved above neutral earlier this month for the first time since February, Deutsche Bank data showed.

Meanwhile, options investors are buying calls - bets on upside in stocks - at levels not seen in years. A record 1.8 million S&P 500 calls traded on Thursday, helping lift the one-month moving average of calls-to-puts to the highest in at least four years, Trade Alert data showed.

"If you've been fighting this market, you're very likely exhausted," said Emily Roland, co-chief investment strategist at John Hancock Asset Management, who has been increasing overall equity allocations.

The latest gains are fueled by factors ranging from a U.S. economy that has so far avoided recession despite the Federal Reserve's aggressive monetary policy tightening to growing buzz over advances in artificial intelligence.

Some Wall Street banks are revising forecasts for how high stocks can go. Among the latest is Goldman Sachs, whose strategists raised their year-end S&P 500 target to 4,500 from 4,000, citing expectations the economy is likely to avoid a downturn in the next 12 months. The index ended on Friday at 4,409.59, up 23% from its October lows.

Willie Delwiche, investment strategist at Hi Mount Research, said improving sentiment is poised to support stocks, provided it does not become too extreme.

"Shifting from pessimism to optimism is actually what gives lifeblood to bull markets," he said. "You run into trouble when you get to excessive levels, but ... we're not there."

One measure of sentiment that Delwiche studies, the American Association of Individual Investors survey, showed bullish sentiment outpacing bearish sentiment in the latest week by the widest margin since November 2021.

Continued strength in stocks would be consistent with previous periods when pessimism began unwinding while optimism accelerated, Delwiche said.

History also shows stocks tend to keep rallying after rising 20% above their lows. The S&P 500 has posted a median gain of 18% in the 12 months after clearing the 20% threshold, LPL Financial data showed.

Still, some worry stocks are already getting overheated.

Brent Kochuba, founder of options analytic service SpotGamma, said that while extreme levels of call option buying can support markets, it also warrants caution in the near term.

"The trend is probably higher ... but in the very short term we have gotten over our skis," he said.

Matt Stucky, senior portfolio manager of equities at Northwestern Mutual Wealth Management Company, believes sentiment - as evidenced in the AAII survey - has soared too quickly. He believes the Fed's rate hikes are likely to bring on a mild recession late this year or in early 2024. The Fed left rates unchanged earlier this week but said more increases may be necessary this year.

"You're starting to see quite a bit of evidence that investors are chasing this rally," he said. "We're starting to take a little bit off the table."

Others, however, believe the rally has room to run. One encouraging signal is that a greater number of S&P 500 stocks are heading higher, in addition to the handful of megacap growth names such as Microsoft (MSFT) and Nvidia (NVDA) that led gains this year.

Small caps and industrial shares - long-time laggards - have outperformed so far this month, for example, while the number of S&P 500 stocks trading above their 200-day moving average rose to two-month highs this week.

Ken Mahoney, CEO of Mahoney Asset Management, has been adding to positions in Microsoft and Nvidia in recent sessions. Massive call buying, fear of missing out and bearish investors reversing their bets are likely to continue taking markets higher for now, he said. "The market is overheated and everyone and their grandmother can see it, but it may take some time before we see a blow off top," he said. 

Ken Mahoney is right, the market is overheated and as I warned a month ago, it can grind higher before a nasty and prolonged recession takes hold and it implodes.

It's Saturday, I didn't feel like blogging yesterday as I was tired and pulled a muscle in my lower left back (it's better today). 

It's also Grand Prix weekend and people are out enjoying the festivities (too bad it's cloudy, wet and cold) but alas, I saved $1,000 a ticket and didn't go party it up at the Ritz-Carlton last night (with my aching back and walker, that would have been funny!).

Nope, I was out cold by 9:30 p.m. and woke up at 5:30 a.m. today to read about markets.

Before I get into it, let me show you some charts beginning with the Nasdaq:

As you can see, "Sell In May and Go Away" not only didn't work this time, the market has melted up driven by a handful of mega-cap tech stocks (Apple, Microsoft, Nvidia, Metaverse, Aphabet, Amazon, and Tesla).

In fact, if you look at the S&P Technology Index (XLK) where Apple Microsoft and Nividia make up 55% of the ETF, it's really on fire this year  and could soon make a new all-time high:


What's driving this optimism? AI, of course, and stupid investors chasing this rally fearing they're missing out of the start of a new bull market.

But as I have repeatedly warned, as the absolutely insane (AI) market reaches new levels of delusions, one thing is for sure: the worst isn't behind us, it lies straight ahead.

I know, the Fed decided on a "hawkish pause" this past week, markets are ignoring central bankers, we keep grinding higher and higher and to be brutally honest, it's the bears that are getting their asses kicked so far this year:

And the bulls are out full force telling us to still view this year "as full of opportunities":

My take? This market melt-up in a handful of mega-cap tech stocks feels a lot like 1999-2000 and investors better start worrying about risks going forward:

What about the recession, is it still coming? You bet it is:

If I hear one more idiot tell me how "Trahan and you were wrong on markets," I'm going to lose it on them.

Sure, the pain trade has been a market melt-up so far this year, I'll give you that and I personally am having my best year ever (more like EVER) trading everything from mega-cap tech to small-cap biotech to heavily shorted crap like Carvana!

So what? It doesn't change my mind that this red hot stock market driven by the "Magnificent Seven" which includes "TESLA" is in for a major selloff.

Will it be in July? August? September of October? 

I don't know the exact timing but it will be in the second half of this year and it will be BRUTAL.

That much I guarantee you.

So, just like you wouldn't go driving on the racetrack with professional Formula 1 drivers, be careful chasing hot stocks because they're up huge, when they pull the rug under this market, many FOMOers will slam into a brick wall.

Below, Fundstrat Global Advisors' Managing Partner Tom Lee on why he's riding the pain trade higher.

Second, Ryan Detrick, Carson Group chief market strategist, joins 'Closing Bell' to discuss why this stock market rally has a lot of legs, Detrick's price target for the S&P 500, and the when the index could hit a new all-time high.

Third, Allan Boomer, chief investment officer at Momentum Advisors, and Ed Yardeni, president of Yardeni Research, join 'The Exchange' to discuss earnings picking up as profit margins improve, fears of a Fed over reaction, and consumer resistance to price increases.

Fourth, Stephen Suttmeier, Bank of America chief equity technical strategist, joins 'Closing Bell Overtime' to talk the 'FOMO' market rally, an improvement in market breadth, and more.

Fifth, Carter Worth, Worth Charting, joins 'Fast Money' to talk gains in small cap stocks and where those gains could potentially come from in the current market.

Sixth, Chris Murphy, Susquehanna co-head of derivative strategy and CNBC's Bob Pisani join 'The Exchange' to discuss SMH ETF making gains, put trading in the airline space to finance upside call spreads, and possible catalysts for a market pullback.

Laslty, Jeremy Siegel, professor emeritus at the Wharton School and senior economist to WisdomTree, joins 'Halftime Report' to discuss market momentum in tech, the Fed's use of lagging indicators, and the probability of recession.

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