If this stocks are feeling frothy to you, there’s one expert investor who wouldn’t blame you for not getting in on this bull run.
Mohamed El-Erian said this week that he’s reluctant to buy into the stock rally that has seen the S&P 500 gain 34% since the March 23 bottom.
“For me personally, it’s an uncomfortable bet to continue to get on a huge recovery,” El-Erian, the chief economic advisor at Allianz, said. “I don’t like doing this. But I respect and admire those who can.”
Investors have been pushing stocks higher on optimism around reopening and the hopes for a rapid rebound in the economy. But bubbly price moves in the stocks of bankrupt companies, surging activity by small investors in stock options, and a big rally in penny stocks may all be a signal that the market has run too far.
And Thursday’s big fall, the largest single-point drop since March with the Dow plunging 1,861.82 points, seems to indicate that froth may be beginning to unwind.
“Now you have frothy retail behavior on top of stretched sentiment on the part of professional investors, and it’s definitely a warning sign,” said Peter Boockvar, chief investment strategist at Bleakley Advisory Group. “Does it really matter today, or does it matter two weeks from now? But from strictly a contrarian standpoint, it’s got to be a red flag. It’s not making a long-term statement. It’s not telling you it’s the end of the bull market. It just tells you right now, at this moment in time, there’s a lot of speculative behavior that should be heeded in the short term.”
Michael Kantrowitz, chief investment strategist at Cornerstone Macro, said that stocks taking just two months to rebound to pre-coronavirus-market-crash levels even as it becomes clearer that it will take the economy at least a couple of years to do the same is looking like a bubble. Especially given that the S&P 500 is trading at about 22 times forward earnings, a level last seen around the time of the tech-stock bubble.
“In the past few months, and for the first time in the data, stocks are nowhere near fundamentals,” Kantrowitz said. “It smells a bit like irrational exuberance.”
For El-Erian, the decision on whether to buy into this market depends on how well an investor tolerates risk and suggested investors ask themselves a few questions before jumping in on the rally.
“I’ve got to stress, this is a very personal choice,” El-Erian said. “How else are you exposed? Are you structurally exposed to the market? Should you also be tactically exposed to the market?”
El-Erian concluded that the market will continue to be bolstered by the Fed’s massive monetary stimulus, near zero interest rates, and open-ended asset buying. But the market tis in a precarious position and a shock from something it isn’t yet pricing in—a second wave of the coronavirus, say—could send stocks tumbling.
“The narrative has has been win-win,” El-Erian said. “You win if you look through all the bad data and bet on a massive recovery. And you still win because the Fed will support you all the time. That narrative is so deeply embedded now that it takes a major shock to change it.”