MW These three things make this bullish Wall Street pro question whether stocks are still worth the risk
By Joseph Adinolfi
DataTrek's Nicholas Colas remains bullish, but says these three things make him question his faith in stocks
Being long U.S. stocks - especially large-cap U.S. stocks - has paid off for investors over the long term. But at least one stalwart bull is starting to question whether they are still worth it at current levels.
And it isn't just stocks' relatively high valuations that are giving Nicholas Colas, co-founder of DataTrek Research, pause.
In emailed commentary shared with MarketWatch and DataTrek clients on Friday, Colas highlighted three "bothersome things" that are making him question his optimistic view on stocks.
"These are issues that nag at us pretty much every day, the troubling thoughts which live in the corners of our otherwise optimistic view regarding U.S. large cap equities," Colas said.
"While they are not enough to make us turn cautious, they do deserve attention."
U.S. stock valuations are extremely high
Any way you look at it, large-cap U.S. stocks are extremely pricey right now.
Perhaps the most popular method for valuing stocks is the price-to-forward earnings ratio, which compares a company's current valuation to how much Wall Street analysts expect it to earn during the current year.
As of Friday, the S&P 500 index was trading at 20.6 times aggregate expected earnings for its constituents, which was above its five-year and 10-year average, according to FactSet data.
But another more conservative valuation metric suggests stocks' levels are even more extreme, even after the modest pullback that has rattled markets in April.
Known as the Shiller cyclically adjusted price to earnings ratio $(CAPE)$, this gauge substitutes average earnings over the past 10 years for Wall Street's year-ahead forecasts.
It currently stands at 33.3 times earnings for the S&P 500, nearly double the long-run average of 17 times, Colas said. The only examples where it was higher were during the late 1990s dot-com bubble, and the speculative-technology frenzy in late 2021.
There is one thing Colas found that might explain the surge in valuations: since the mid-1980s, U.S. corporations have seen profit growth as a percentage of GDP increase dramatically, rising from 6% to 13%.
"Current multiples are higher than any point since World War II, but so is corporate profitability relative to economic activity," he said.
Will artificial-intelligence really see rapid mass-adoption?
The advent of generative artificial-intelligence is often cited as a key driver of the latest bull market in stocks, given the technology's potential to boost workers' productivity. Still, Colas has his doubts about the potential for AI to see such rapid mass-adoption.
During the latter half of the 20th century, the pace at which consumers' adopted new technology increased remarkably, but Colas pointed out that past innovations were mostly hardware. The fact that generative AI products like ChatGPT are instead software innovations could render this a moot point.
"Comparing their adoption rates to what Gen AI may see is potentially apples and oranges," he said.
Treasury yield curve remains inverted
The spread between short-dated and long-term Treasury yields has been inverted for the longest stretch on record. In the past, an inverted yield curve has predicted recessions with almost unerring accuracy.
It appears to have failed this time around, but Colas said there is still scope for an unexpected shock to the economy to emerge to restore the indicator's status as a reliable recession gauge.
"The Fed's recession model will almost certainly continue to be wrong until we get an exogenous shock. We have managed to avoid one so far, which is very good news indeed," Colas said.
"But the intersection of relative Treasury yields and eventual recession, which is a time-proven relationship, says it is wise to remain a bit wary."
U.S. stocks traded mostly lower on Friday, with the Dow Jones Industrial Average DJIA up 160 points, or 0.4%, at 37,934, while the S&P 500 SPX and Nasdaq Composite COMP were down 0.6% and 1.5% respectively at 4,981 and 15,362.
Treasury yields were modestly lower, with the 10-year BX:TMUBMUSD10Y down 2 basis points at 4.62%.
-Joseph Adinolfi
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April 19, 2024 13:13 ET (17:13 GMT)
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