Are Markets Giving An “All Clear” Signal?
The S&P 500 rallied to a two-plus month high last week mainly on the larger-than-expected tariff reduction between U.S. and China, but also because of better-than expected inflation data (CPI/PPI) and more signs of positive economic activity despite tariffs/ policy chaos (a lot of M&A last week and a successful IPO). That good news helped push the S&P 500 above 5,900 and it has now not just retracted the entire “Liberation Day” declines, but also basically all of the Mexico/ Canada, steel and auto tariffs selling as well.
Not surprisingly, investor sentiment has shifted dramatically as numerous sentiment indicators have switched from fear/ bearish to greed/bullish (the CNN Fear/Greed Index in particular leapt to nearly “Extreme Greed” readings this week). Put simply, the market is acting well, investors are optimistic and the outlook is much, much better than it was a few weeks ago. So, is the market giving an “all clear” signal to investors?
No, I don’t think so. At least, not yet. First, the news lately has been undeniably positive but it hasn’t been this positive to send the S&P 500 back to early March levels, and the reality is that much of this recent rally has been driven by investors (especially institutional investors) finding themselves too bearish/under invested and chasing stocks higher.
Put differently, obviously the news recently has been good, but I think you’ll struggle to find honest analysts who think it justifies these valuations or this rally. Additionally, there are still storm clouds on the horizon. While the U.S./China tariff reduction was obviously the most important event of the week, I believe the second most important event of the week was Walmart’s earnings release and specifically the warning by Walmart’s CEO that consumers would see tariff-related price increases starting in late June and ramping up substantially in July.
If any firm is going to combat price increases as hard as possible, it’s going to be Walmart, so the fact that they are warning that even they are unable to counter them should serve as a warning for other retailers. Now, to be clear, that doesn’t mean we’re going to see stagflation (at least not extended stagflation), but it does mean it’s simply too early to get too optimistic on this economy or market.
Maybe the price increases we see starting later next month and into the summer won’t be that bad. But the point is we don’t know that and it’s prudent to “wait a bit and see” before getting too aggressive on equity valuations. Point being, Walmart just told us it’s too early to dismiss the risks of stagflation, and as such, I do not think we should.
Bottom line, the S&P 500 is trading over 22X earnings and from my experience, that’s simply too expensive given the looming number of unknowns out there on growth and inflation. And Walmart’s commentary reinforces that point and validates my continued preference for more defensive, lower-volatility sectors and factors. Finally, I’m not being a pessimist or a perma-bear here. I just think it’s too early in this drama to get this aggressive on valuations for stocks because in my experience everything in the economy takes longer to show up then people think and Walmart’s commentary largely reinforced that view.