It’s been about 25 years since Wall Street had a serious bear hunt. And it appears another one is starting up now.
Early on Aug. 27, 1999, the finance world was rocked by the resignation of one of its most committed pessimists, Charles Clough, Merrill Lynch & Co.’s chief investment strategist. Clough’s opinion was highly regarded, but he’d committed the stock market’s cardinal sin, remaining bearish in the face of a relentless rally — in this case, the dot-com frenzy that sent the S&P 500 Index soaring 220% from the start of 1995 to the end of the century.
That may feel like a long time ago, but on Wall Street, as in Shakespeare, the past is often prologue. And so, the abrupt exit of Marko Kolanovic last week after 19 years at JPMorgan Chase & Co. is reminding many traders, bankers and analysts of Clough’s adieu. Once again, a prominent strategist was taken down after his warnings of an imminent equities crash never materialized and the S&P 500 continued to hit fresh highs over and over again.
Now some investors are wondering if the whole saga is a sign that the market is peaking.
Follow Clough’s story to its conclusion and you’ll see that he was quickly vindicated. By March 2000, the Internet bubble was starting to deflate, and on April 3 the Nasdaq Composite Index posted its largest point decline ever up to that point. It kept falling from there, ultimately losing more than half of its value by the end of 2001. It wouldn’t see its 2000 high again until 2015.
The fear is history is about to repeat itself, as the erasure of cynics is something that typically happens toward the end of market manias.
“Is Marko’s situation a classic sign of a market top?” David Rosenberg, founder and president of Rosenberg Research, asked rhetorically. “There are a lot of market topping characteristics that you can point to. And I would say this may well be one of those.”
Endangered Bears
The thing is, Kolanovic isn’t alone. Just months before the announcement that he was “exploring other opportunities,” another celebrity bear who wrongly predicted a rout, Morgan Stanley’s Mike Wilson, stepped down as chair of the firm’s global investment committee, a post he’d held for a decade. Since then, he has toned down his skepticism about the stock market’s advance.
Clough and representatives of JPMorgan and Morgan Stanley declined to comment.
In many ways, this is a story as old as Wall Street. Going against the herd in a bull market can make your clients and employer “increasingly dissatisfied with you,” said Rosenberg, who correctly sniffed out trouble in the US economy ahead of the global financial crisis as an economist at Merrill Lynch.
Consider the case of veteran strategist Gail Dudack. From 1987 to 2000, she worked at Warburg Dillon Read (since acquired by UBS Group AG). In November 1999, Louis Rukeyser, host of “Wall Street Week” on PBS, booted her off his “elves index” for being too bearish. “Elves” was his nickname for the cohort of technical analysts who appeared regularly on the program.
“When you start shooting the bears, it’s kind of a classic signal,” she said.
There’s no doubt that the stock market is showing some characteristics of a bubble, particularly in the record-setting surge by a few key technology giants expected to benefit from the development of artificial intelligence. Some on Wall Street, including Kolanovic, have pointed to froth in indexes led by those Big Tech companies. Others argue that earnings justify the market’s expansion.
Regardless of who’s right, the key is bubbles can keep inflating far beyond reason before they burst.
“Bubbles are all about momentum,” Dudack said. “They’re run by a collection of stocks. The thing is, they will work because momentum begets momentum.”
In this case, if the AI boom morphs into an AI bubble, strategists at Societe Generale SA estimate the S&P 500 can inflate another 20% or so before it reaches valuations similar to that of the dot-com peak. The index is currently trading near 5,600.
Risk Blind
This explains why so many on Wall Street seem blind to the potential risks right now. At the close of last year, the median strategist forecast for the S&P 500 in 2024 was 4,850, last month it was 5,450. Goldman Sachs Group Inc. and UBS have raised their predictions three times since the end of 2023, while Oppenheimer Asset Management, Citigroup Inc. and Deutsche Bank AG recently increased theirs.
State Street Global Advisors chief investment strategist Michael Arone just recently channeled an infamous line from ex-Citigroup CEO Chuck Prince in July 2007, when he said his bank was “still dancing” as the global financial crisis was getting started.
“A restrictive Fed won’t stop the music this time around because the economy’s moving to a new rhythm,” Arone wrote in a memo on July 8, citing AI’s potential to generate a “prolonged and unprecedented productivity miracle.”
But a small corner of the market is starting to see this groupthink as a cautionary sign. Scott Rubner, Goldman’s tactical specialist and global markets division managing director, warned of an imminent correction “as the last standing bears have capitulated and everyone is in the pool.”
It’s enough to make even long-time bulls wonder if the rally has gone too far. For example, Ed Yardeni of Yardeni Research wrote in a note to clients this week that the departure of Kolanovic, as well as Piper Sandler & Co.’s decision to drop S&P 500 price targets, were potential bearish signals.
“Some of my best friends are bears,” Yardeni said. “I think the ones on Wall Street do excellent work. They provide us with lots of reasons why things could go wrong, and some of them have been called permabears as a result.”
However, the warning signs aren’t enough to shake Yardeni’s faith in stocks. On Thursday, he raised his year-end target for the S&P 500 to 5,800 from 5,400 — and reiterated his prediction that the index will hit 8,000 by the end of the decade. He even said those targets may be realized ahead of schedule.
“I’ve often been called a permabull, which I’m kind of proud of, because I want it to say on my tombstone that Yardeni was usually bullish — and usually right,” he said. “Just looking at the trend of the stock market, it usually goes up rather than down.”
Back in 2005, before the GFC hit, Tom Barrack who was then considered the world's best real estate investor sold everything famously stating this:
"There's too much money chasing too few good deals, with too much debt and too few brains." The amateurs are going to get trampled, he explains, taking seasoned horsemen, who should get off the turf, down with them. Says Barrack: "That's why I'm getting out."
He was early but absolutely right on his call.
Fast forward to 2024 where all the rage on Wall Street is about "private credit" and some are openly wondering whether all the financial engineering going on in private equity will cause the next systemic crisis.
I'm not sure about that, there are good private equity funds and a lot of not-so-good ones who take stupid risks but clearly today's financial system is a lot more levered and financed by global financial flows, be it in private markets or public markets.
In public markets, Jim Perry of Perry International Capital Partners sent this in his weekly bulletin at the start of the week:
The S&P 500 was up only 6% with below-average volatility, but beneath the surface, we are witnessing extraordinary divergences as the economy becomes increasingly bifurcated. Artificial intelligence has been the fuel propelling stocks since November 2022, and the second quarter of 2024 is no different. Within the S&P 500, companies related to the AI theme gained 14.7% in market value in Q2, whereas the rest lost 1.2%. Microsoft is the world’s most valuable company,worth $3.475t. Apple is worth $3.470t, and Nvidia is worth $3,095t. Their gains this year are simply staggering.
Bifurcation is clearly seen in the world’s economies and markets. It’s not just the Mag 7 vs. the other 493… it’s also Eli Lilly and Novo Nordisk against the rest of the healthcare index.
Markets are changing rapidly—investors need to realize this is vital to understand what’s happening. Last week, Market Watch interviewed Jeffrey Bierman, Theo Trade’s chief market technician and an adjunct finance professor at Loyola University in Chicago. He said algorithmic trading is taking big-cap tech stocks higher—not greedy individual investors. He asserted that the S&P 500 has become a one-sided market with very low volatility and that only one sector is carrying the market. People are conditioned to chase the story and buy momentum with the help of algorithms, which buy strength
and sell weakness. Algos do not buy weakness; people do.
Jim summed up his thoughts and recommendations in a one pager I share with you:
Let this sink in: at the start of the week, year-to-date the Mag 7 was up 48%, the S&P 493 was up 7.5%, and the Russell 2000 was down -0.1%.
This week is pretty much a continuation of this trend even with the Mag 7 hiccup on Thursday led by Tesla's one day selloff (it popped back up nicely today along with Nvidia, both are up 3% or more early this afternoon).
If you don't think Citadel and other elite hedge funds are long Mag 7, short Russell 2000 and pretty much everything else, you're living in La-La Land.
In fact, what amazes me about 2024 is how elite hedge funds have been able to play this Mag 7 game for so long. When one is down, like Tesla in mid-April, no problem, the algos scoop it right up:
I've never seen anything like it. It's as if sovereign wealth funds, hedge funds, mutual funds are all chasing returns at any cost.
And as long as volatility remains historically low, this strategy works, but this isn't alpha, this is what I call leveraged insanity.
When the music stops, a lot of these momentum players are going to get utterly destroyed but the duration of this rally is on their side and it's bears who are suffering the consequences whereas clueless bulls keep upping their targets and riding the giant beta wave up.
Well, I'm here to tell you the US economy is definitely weakening, unemployment rate will start creeping up, this week's tame US CPI report confirms the Fed will cut rates in September, maybe even before.
And that's when the music stops and reality will set in.
Stocks are having one last party but it's all about to end abruptly and those Wall Street strategists that keep upping their target on the S&P 500 (which is really a call on Mag 7) are going to look like utter fools and clients are going to wish they listened to Kolanovic, Trahan, Wilson and other bears like Peter Berezin, Chief Global Strategist at BCA Research who now predicts the S&P 500 will drop by 32%, reaching 3,750 in 2025.
He attributes this anticipated decline to the Federal Reserve’s inability to prevent a recession.
In show business and stock market prediction business, timing is everything, and timing the end of this mega bull market which has been supported by global flows is very hard.
But here is some food for thought. Earlier this week, we learned about how Australia's largest pension fund is now going overweight Big Tech stocks as "AI will fuel further gains for this sector."
Colour me skeptical but when I see large pension funds going overweight Big Tech, I know the top is near.
And here is some more food for thought, global investors better pray inflation remains tame for the rest of the year and after the US elections because if it doesn't and a second wave materializes like in the 1970s, markets are cooked, literally cooked:
Economists say inflation follows the EXACT footsteps of the 1970s
— Game of Trades (@GameofTrades_) July 11, 2024
They are wrong about what’s coming next
A thread 🧵 pic.twitter.com/DcCRbw2VGq
Anyway, for now, just act like algos, hold your nose and buy momentum and pray you don't wake up one day and futures are limit down.
But if you want my advice, listen carefully to some of the bears out there:
I just heard on CNBC that we have not seen a day like this with the S&P 500 down size and the Russell 2000 ripping since October 2008. Is that a factoid that should be making us feel good? The S&P 500 went down more than 20% over the ensuing five months.
— David Rosenberg (@EconguyRosie) July 11, 2024
Below, Philippe Laffont, Founder & Portfolio Manager, Coatue Management sits down for a special feature of Bloomberg Wealth with Host, David Rubenstein to share his current investment outlooks and strategies for delivering in today’s fast moving market at the Bloomberg Invest conference in New York.
And Cliff Asness, Founder, Managing Principal & Chief Investment Officer, AQR Capital Management talks to Bloomberg’s Sonali Basak about how AQR is still winning despite today’s wild markets, and how the quant firm has changed in the last decade at the Bloomberg Invest conference in New York.