On the US market surge, some Wall Street institutions are issuing cautionary statements, stating that inflated valuations have left equities more susceptible to falls.
The S&P 500, which has up more than 13% year so far on the strength of signals of lowering inflation, enthusiasm over developments in artificial intelligence, and rising risk appetite, declined for the week.
However, those increases have driven up the price of stocks. According to Refinitiv Datastream, the S&P 500 currently trades at 19 times its estimated 12-month earnings, a significant premium to its historical average of 15.6 times.
Periods of rough performance have been preceded by comparable valuation levels. According to Goldman Sachs, the S&P 500 has historically had a median drop of 14% over next 12 months when values are at present levels or above, as opposed to a 5% drop over a usual 12-month period.
Investors warned catalysts such as unexpectedly weak economic growth, the possibility that the Federal Reserve may be more aggressive than markets have priced in, and a rise in inflation could all cast a shadow over the economic outlook.
Recent downgrades by WFII to neutral from favorable, citing unappealing values, were made to the tech sector, which has been driving this year's S&P 500 gain.
Despite their expectation that the S&P 500 will end the year reaching 4,500, or roughly 3.5% above its present level, Goldman advised investors to add "downside protection" into their stock portfolios.
The Nasdaq 100, whose 36% rise this year has surpassed that of the S&P 500, is valued at an even higher premium. Refinitiv Datastream reports that the index traded at nearly 27 times future earnings forecasts as opposed to its historic average of 19.3 times.
It is harder to defend high valuations now because the Nasdaq 100's high-growth companies have a more muted profits forecast than it did in 2021, while the index also experienced a rapid rally, according to Tallbacken Capital Advisors CEO Michael Purves.
Despite the index's enormous gains, Purves noted that technical momentum and trend indicators are beginning to show signals of fragility.
He used the acronym FOMO - fear of missing out, to describe the current situation, saying that this entire fantastic momentum, is beginning to become a little long in the tooth here. This resembles a flashing yellow warning light, sort of.
As the second quarter of the year comes to an end, investors will be keeping an eye out for additional economic data the following week, particularly crucial inflation data on Friday.
Other justifications for caution have been given by market participants, including the possibility that some of the tailwinds which have recently supported stocks may be losing steam.
One of those is positioning: Over the past few weeks, investors have piled into stocks out of concern that they may miss out on future gains. The greatest investor positioning in equity since January 2022, according to a metric tracked by Deutsche Bank.
While the switch to stocks has supported markets, it also reduced the amount of fuel available to drive future advances.
According to Goldman's experts, the equity market should no longer benefit from light positioning.
Undoubtedly, there are indications that the surge may continue. Some investors believe that stocks are currently in a "bull market" stage as a result of the S&P 500's more than 20% rise from its October lows. History also shows that stocks typically continue to rise once they reach the 20% level.
This month, sectors like materials and industrials have also performed better than expected, boosting hope that the rally may spread beyond the small number of tech and other megacap firms that have mostly driven this year's gains.
Anthony Saglimbene, a chief market strategist from Ameriprise Financial, stated that a growing surge should give investors a little bit more optimism. But he said that the index's abrupt rise over its short-term and long-term technical trend lines may indicate a forthcoming decline.
Investors should expect markets to just cool off a little bit in the near term.