Stock Market

Economist Who Called ’08 Recession Warns of Bubble

The famed economist who called the 2008 recession while working for Merrill Lynch said in a note to his Rosenberg Research clients on Friday that he’s increasingly convinced the S&P 500 is overextended, and that a day of reckoning awaits somewhere down the line, even if it won’t be in the immediate future.

“If I was skeptical a year ago, I remain even more so now,” Rosenberg said. “I don’t tend to chase manias, and I never chase bubbles. I have and always will preach the preservation of capital and preservation of cash flows, including diversification. Just because the current valuation backdrop isn’t as extreme as 1999-2000, we are still in a market bubble, and valuations are even more stretched today than they were at the market peaks in 2007, 1990, and 1980.”

He continued: “Momentum-driven markets can be very powerful beasts over the near term, but fundamentals always win out, and the starting point for the multiple always and everywhere acts as either a long-term tailwind when they are in the bottom 10% or a headwind when they are in the top 10%, as is the case today.”

Rosenberg cited his proprietary US Equity Model as one piece of evidence that stocks are in a bad place. The model considers valuations, technical indicators, investor sentiment, and investor positioning. Right now, it’s at its most extreme bearish levels, he said, just as it was in January 2022 before the market dropped 25% over the following nine months.

Rosenberg Research equity model

Rosenberg Research

3 signs of technical weakness

Rosenberg also cited three technical indicators that show weakness underneath the surface of the broader market, despite the strong performance of indexes like the S&P 500 and the Dow Jones Industrial Average. While some of the top names in the market are dragging the overall index higher, smaller names in the market aren’t participating as much in the rally, which can be a sign of an unhealthy market.

Here’s the Dow’s performance compared to the Dow Transports Index, a cyclical market sector that tends to do well when the economy is healthy.

dow/dow tranports

Rosenberg Research

Second, the S&P 500 is outperforming the HYG/TLT Ratio. HYG is a high-yield corporate credit ETF (offering exposure to riskier bonds), and TLT is a long-term Treasury bond fund (offering exposure to risk-free bonds). In a true risk-on environment where investors are more inclined to put money into lower-quality bonds, Rosenberg said, HYG would be performing better than TLT. Given that stocks are risk assets, there’s a divergence in performance that shows stocks’ stellar returns may not be sustainable.

sp500 vs hyg/tlt ratio

Rosenberg Research

And third, even tech stocks, which have been overwhelmingly supporting the S&P 500, appear to be running out of gas, Rosenberg said. The chart below shows the S&P 500’s tech sector performance relative to the overall index.

sp 500 vs tech sector

Rosenberg Research

Rosenberg’s views in context

Rosenberg seems to be one of the last bears standing on Wall Street, and is calling for both stock market underperformance and a recession. As the labor market has proved resilient and inflation has remained subdued, recession forecasts have dissipated and investors have piled back into stocks. Excitement about artificial intelligence has also led to large inflows and helped to propel the market.

But even as the bullish narrative prevails today, some market observers have recently expressed concerns about the rally’s potential to continue in the months ahead.

Bank of America’s Chief Investment Strategist Michael Hartnett said in a client note earlier this month that the S&P 500 continues to approach bubble territory, and pointed out that concentration in semiconductor stocks is now higher than it was during the dot-com bubble in 2000.

semis vs sp500

Bank of America

Valuations are also a point of skepticism for many, with investors carrying extremely high expectations. Jeremy Grantham, the founder of GMO who called the 2000 and 2008 crashes, said in a recent report that this is one reason he continues to reiterate his bubble prediction.

The same goes for Paul Dietrich, the chief strategist at B. Riley Wealth, who says the S&P 500 could fall 49% when the current bubble pops.

“The stock market is basically priced for earnings growth that has only happened 3% in the past, and that percentage has generally happened when the economy was coming out of a severe recession,” he said.

Even those with more moderate outlooks than Dietrich and Grantham see the potential for a near-term correction, given where investor expectations are.

“Current levels in stocks leave little room for disappointment and we wouldn’t be surprised to see a pullback at some point and such a retracement would be normal in the overall bullish trajectory that we are in,” said Carol Schleif, the chief investment officer at BMO Family Office, in a memo on Friday.

Market price action in the months ahead will show whether downside calls from Rosenberg and other bears will finally come to fruition. The bull market has thrown egg onto their faces again and again: since the October 2022 lows, the S&P 500 is up a whopping 42%.

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