The stock market's stunning comeback this year is causing some investors and analysts on Wall Street to worry that the rally is being driven by irrational exuberance. But several key indicators suggest that worries of an overextended market are overdone and that a meltdown is unlikely. The reasons: a majority of stocks are still below their 52-week highs, a minority of stocks is in overbought territory, and volatility is subdued, according to Bloomberg.
The relative lack of volatility is particularly noticeable in the market’s leading sector: technology. That's even though technology hardware and equipment, semiconductors, and software and services have booked gains of more than 20% this year.
3 Signs Stocks Aren’t Overheated
What it Means
The S&P 500 hit its most recent high in September of last year before plunging nearly 20% by the end of December. Since then, stocks have rallied, pushing up the index sharply. Even with those gains, the vast majority of stocks have not yet reached previous highs as investors appear to take a much more cautious approach in this rally. That includes more diversified strategies, with investors putting sizable money into bonds.
While this year’s quick turnaround may seem to scream too much too fast, relative strength indicators also are helping to dispel worries. This momentum indicator captures the magnitude of recent price changes in a security. A reading greater than 70 is generally interpreted as indicating that a stock is overbought, while a low reading suggests the stock is oversold. Only 10% of S&P 500 stocks are currently in overbought territory.
Current volatility levels are also suggestive of relative calm. While late December saw the VIX spike to levels comparable to February 2018 when markets made a similar plunge, it is currently sitting at much lower levels.
But it’s not just the charts that are expressing optimism. The vast majority of Wall Street professionals say there will be no recession over the next year, according to a CNBC survey. Also, over half of the respondents said Q1 earnings would top expectations and the leading sectors will be tech, health care and energy.
While there are reasons to be optimistic, Q1 earnings reports are expected to show falling profits for S&P 500 companies as a group, a dramatic reversal from the past few years. The tech sector is especially vulnerable. “The inflection in tech margin misses is not a smoking gun, but it is a warning sign that earnings estimates may still be too high and we remain on the lookout for weakening guidance,” wrote Morgan Stanley chief U.S. equity strategist Michael Wilson.