By Lewis Krauskopf
NEW YORK (Reuters) - A record-setting run in U.S. stocks has made some investors wary as concerns grow over the market’s vulnerability to surging inflation, tighter Federal Reserve policy and moderating corporate profit growth.
The S&P 500has gained about 24% so far in 2021, and on Monday finished a streak of eight straight all-time closing highs, the longest such stretch since 1997. The benchmark index has more than doubled since its March 2020 low at the onset of the coronavirus pandemic, minting 65 all-time highs in 2021 alone, the second-most of any year on record, according to LPL Financial.
With those gains have come potential pockets of excess that some investors worry are emblematic of a market that is overheating, even as inflation soars to its highest levels in decades and the Fed prepares to tighten monetary policy next year.
Some examples include the eye-popping gains for Tesla Inc (NASDAQ:TSLA) and Nvidia, the blockbuster initial public offering of electric vehicle maker Rivian, which garnered a valuation over $100 billion despite having little revenue, as well as Bitcoin’s surge to an all-time peak.
More broadly, the S&P 500 tech sector's valuation, based on forward price-to-earnings ratios, is near a 17-year high.
“There are very reasonably valued stocks and portions of the market, and so that is what I am trying to gravitate to," said Walter Todd, chief investment officer at Greenwood Capital in South Carolina.
"But as somebody who has been doing this for a while, (the market) seems... excessive in certain respects.”
His firm owns stocks such as pharmaceutical company Pfizer (NYSE:PFE) and tech stalwart Cisco (NASDAQ:CSCO) for its clients.
Some of the worries may be starting to take their toll. Stocks have wobbled in recent days, endangering a sixth week of positive returns for the S&P 500. The CBOE Market Volatility index, known as Wall Street’s fear gauge, on Wednesday hit its highest level in a month.
Based on the level of the 10-year U.S. Treasury yield, Morgan Stanley (NYSE:MS) strategists said in a note on Monday that the S&P 500 should be trading at about 20.5 times forward earnings estimates, as opposed to its current level of 21.5 times.
"We think retail flows, seasonal strength and institutional 'FOMO' have taken valuations above fair value," the Morgan Stanley strategists said, using the acronym for "fear of missing out."
Some investors believe a startling rise in consumer prices to their highest level in more than three decades may accelerate the speed at which the Fed reduces its bond buying and eventually raises interest rates, potentially weighing on stocks and other risky assets. The central bank kicked off an unwind of its $120 billion government bond buying program this month.
U.S. consumer sentiment plunged in early November to the lowest level in a decade as surging inflation cut into households' living standards, according to the University of Michigan's Consumer Sentiment Index released on Friday.
Market participants will also start turning their focus to next year, when S&P 500 profit growth is expected to slow to 7.5% after rebounding an estimated 49% this year following the pandemic shutdowns.
Chad Morganlander, portfolio manager at Washington Crossing Advisors, has been paring back his stock holdings in the past month, reducing equity exposure in some portfolios from an overweight position to neutral and moving more into cash and bonds.
Investors have been "handsomely rewarded" in the wake of the Fed's easy money policies, he said.
"The real question is what to do now," Morganlander said. "Our viewpoint is that you want to try to be a little less risky."
Investors next week will keep a close eye on the latest monthly retail sales report, as well as earnings results from companies including Walmart (NYSE:WMT), Home Depot (NYSE:HD) and Nvidia.
Analysts at BofA Global Research recently wrote that investors’ options bets “reveal mounting demand for leverage as investors chase the market's performance into year-end.” Taken together with the market’s recent run, “we view this as FOMO… not a fundamentally justified rally.”
A Capital Economics report, meanwhile, said the firm’s analysts expect a gradual climb in real yields and underwhelming economic growth to hold back the U.S. stock market.
Whether investors, who have consistently scooped up stocks on pullbacks this year, will actually turn away from equities remains to be seen, in particular with November and December being historically a strong period for the market.
"Are you going to fight the tape?" said Robert Pavlik, senior portfolio manager at Dakota Wealth in Fairfield, Connecticut. "Selling into that strength, people would have caught themselves on the wrong side of the trade and nobody wants to be doing that, especially at year end."