The S&P 500 Hits 5,000: Is The Euphoria a Contrarian Indicator?
Human beings love round numbers. For investors, it’s a risky way of thinking.
Back during the Stone Age, when I was applying to college, some of my fellow students would retake the SAT because their first scores fell just shy of round numbers. In Major League Baseball, a .299 hitter will start swinging wildly during the final games of the season, desperate to hit .300. A used car with an odometer at, say 99,500, will see its value fall exponentially once the mileage hits 100,000.
In all such cases, the substantive differences are negligible. But social research shows that our brains are hard-wired to give disproportionate meaning to zeroes. It stems from our base-10 number system, an anthropomorphic decision that derives from the number of digits on our hands.
The same mental bias affects investing. Big, round numbers can cloud your judgement, tempting you to buy or sell at the wrong times.
Wall Street got excited when the S&P 500 last week surged past the 5,000-mark for the first time in history. Sure, the number 5,000 serves as a captivating psychological threshold. But it’s during moments like this that the contrarian in me starts to worry.
There is some danger in the euphoria over this milestone. Market tops make investors “feel good,” prompting them to pile in when valuations are too high. I’m referring to Fear of Missing Out (FOMO), a risky dynamic. Stocks have gotten pricey, especially the Big Tech stalwarts that have done most of the market’s heavy lifting.
However, to take the optimistic view, 5,000 symbolizes the market’s resilience amid a historically abrupt adjustment in interest rates. I think the bull has further to run, but caution is warranted.
Merely a year ago, concerns of a recession dominated the discourse. With the economy defying predictions of a slowdown and stocks surging approximately 20% over the past quarter, valuations have gotten stretched.
It’s a bullish sign, though, that the consumer continues to hang tough. The consumer stands as the linchpin of the U.S. economy, with personal consumption constituting two-thirds of U.S. gross domestic product (GDP).
Despite elevated borrowing costs and last year’s inflationary spike, consumer spending has persisted at a vigorous pace, bolstering the economic expansion and stock market rally. Notably, discretionary expenditures have flourished, which signals a confident consumer.
A confluence of factors, including surplus savings during the initial pandemic era, a tight labor market, and low mortgage rates locked in by households in 2021, fueled last year’s economic vigor.
That said, signs of consumer fatigue are beginning to emerge. Consumer credit growth slowed in December, escalating merely by $1.5 billion compared to the $23 billion surge in November, with credit card delinquencies on the uptick. Moreover, savings accumulated during the pandemic have largely been depleted among low-income segments, while announcements of layoffs have intensified.
Consumers possess less financial ammunition compared to a year ago, but paradoxically that’s good news. An impeding deceleration in economic growth in forthcoming quarters is disinflationary, which makes it all the more likely that the Federal Reserve will cut rates later this year.
Higher interest rates hurt rate-sensitive sectors last year, but with the Fed poised to pivot, those sectors should rebound in 2024. Housing, utilities, and real estate are on the cusp of recovery.
Another positive week…
As the following chart shows, equities continued their winning ways last week:
The main U.S. stock market indices closed mixed on Monday as follows:
- DJIA: +0.33%
- S&P 500: -0.09%
- NASDAQ: -0.30%
- Russell 2000: +1.75%
The Dow Jones Industrial Average rose more than 125 points to close at 38,797.38, a record high.
Last year, the “Magnificent Seven” tech stocks propelled most of the S&P 500’s gains amid growing enthusiasm surrounding artificial intelligence. These behemoths continue to outperform so far this year, but other segments of the market are closing the gap.
As rates fall and economic growth stays on track, small- and mid-cap stocks should pick up the pace in the coming months. I expect a diversification of stock market leadership in future quarters.
The bull market isn’t just occurring on these shores. As always, international diversification remains prudent. Indices such as the German DAX and French CAC have reached new highs, while Japan’s Nikkei has hit a 34-year peak.
Conversely, the MSCI China Index has retreated by 60% from its 2021 high amid deepening housing woes.
Overall, international equity markets trade at a considerable discount relative to U.S. equities and offer more appealing dividend yields.
The week ahead…
We face a busy week of new economic data on the docket:
Monthly U.S. federal budget (Monday); consumer price index (CPI) and core CPI (Tuesday); initial jobless claims, retail sales, homebuilder confidence, industrial production, Philadelphia Fed manufacturing survey (Thursday); housing starts, building permits, producer price index (PPI), core PPI, and consumer sentiment (Friday).
CPI and PPI will dominate the financial headlines. If these two inflation gauges come in lower than expected, stocks are likely to continue their upward march. The fundamentals, not the S&P 500’s achievement of 5,000 in and of itself, warrant bullishness.
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John Persinos is the editorial director of Investing Daily.