Investors were overly optimistic about the stock market and are starting to pay the price.
Going into the last week, signs of optimism were everywhere: A recent poll by the American Association of Individual Investors showed bulls outnumbering bears by more than 20 percentage points, and Wall Street strategists at banks like UBS, BMO and Morgan Stanley were rushing to raise their price targets. Why not?
S&P 500 Index
It has risen 26% since hitting rock bottom in late October.
But according to Jeff DeGraaf of Renaissance Macro Research, the market can become too optimistic, and that may be exactly where it is right now. He points out that a recent Investor Intelligence survey found that bulls were at 60% even though the S&P 500 has risen about 5% over the past 13 weeks, a figure that’s more in line with a reading below 50%. “As we all know, when bulls become overly optimistic relative to historical returns, returns tend to be below average (though not negative),” he writes.
Of particular concern are fund managers, who according to a Bank of America survey have just 4% of their portfolios in cash. That’s the lowest level in three months, and a drop below 4% is a sell signal, Bank of America said. Anecdotally, fund managers are already starting to get cautious. Ken Mahoney of Mahoney Asset Management says he’s holding much of his remaining cash “because we just came off a good period.” [in stocks]” He added that he would wait for the stock price to fall before buying more.
That hesitation could lead to a shortage of buyers, putting stocks in a vulnerable position. Weakness is already creeping in, with the S&P 500 on pace to drop 1.2% last week.
Dow Jones Industrial Average
Decreased by 2.3%,
Nasdaq Composite Index
It was down 1.1%, but most of the declines this year have been moderate, leading to higher lows and higher highs.
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Still, signs that the market may be about to collapse are starting to appear. First, the market is not responding aggressively to either good or bad news. On Tuesday, the S&P 500 closed little changed despite a better-than-expected rise in consumer confidence, and on Thursday it fell 0.6% despite the Bureau of Economic Analysis lowering its first-quarter U.S. gross domestic product (GDP) growth rate to 1.3% from 1.6%. This is a sign that the market is becoming increasingly fragile.
If Nvidia’s stock stops rising, the vulnerability could quickly turn into a nasty decline. The company’s $2.72 trillion market cap is just over 6% of the S&P 500 market cap, and a decline in its stock price would drag the index down. And other semiconductor stocks would also fall, putting further pressure on the index, especially if non-tech stocks don’t fill the gap. A big decline in Nvidia’s stock is inevitable. The stock has risen almost 200% over the past year, but has seen multiple double-digit declines.
“NVIDIA is sucking all the oxygen out of the room,” said Steve Sosnick, chief strategist at Interactive Brokers.
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Maybe it’s time to hold off and not waste some money.
Corrections and additions
Nvidia’s market cap is $2.72 trillion. An earlier version of this column incorrectly stated the figure as $2.72 billion.
Write Jacob Sonenshine jacob.sonenshine@barrons.com
