The good news is that some indicators remain depressed enough to signal strong potential forward returns. Consumer sentiment in the 6th percentile today remains well below not only the peaks of the nifty fifty and tech bubble, but also their corresponding troughs. Forward average returns from similar starting points have been strong over the next twelve months at +20% for the S&P (85% win rate1) and +22% for the Russell 2000 (78% win rate). Outside of the financial crisis (the conditions for which are not a risk today), the worst twelve-month drawdown seen from this starting point is -7.8%. Also, macro data is showing no signs of overheating, particularly the cyclical components of GDP and leading economic indicators. Coupled with high yield outperformance, the data is inconsistent with an impending recession. Additionally, both the nifty fifty and tech bubble corresponded with a Fed hiking cycle. While the Fed continues to be on pause, fed funds futures prices suggest a 0% probability that the Fed hikes by year-end 2026. While overall market P/E multiples are at the high end of the historical range, the overall market today appears fairly valued based on fundamentals and bond yields, a stark contrast relative to the overvalued tech bubble. This is also true for the top 10 stocks, which ex-Tesla trade at a 25% discount to the top 10 during the tech bubble peak despite generating >2x higher returns on invested capital. Stock performance today appears much more aligned with fundamentals.
Sentiment is far more constrained relative to prior peaks. The University of Michigan Sentiment Index at 61.8 today ranks in the 6th percentile of all readings since its inception. Today’s level is not only well below readings seen during the peak of the 1972 and 2000 bull markets at 101 and 112, respectively, but also their corresponding troughs of 97 and 78. Historically, forward returns from the bottom decile of consumer sentiment have been strong over the next twelve month period at +20% on average for the S&P 500 (85% win rate) and +22% for the Russell 2000 (78% win rate). While other sentiment indicators including the AAII Bull Less Bear Index, CBOE Put/Call ratio, and S&P 500 total put volume have come off historic levels post-liberation day, they remain well anchored relative to the extremes seen during the tech bubble peak.
Macro indicators are showing no signs of overheating. Cyclical components of GDP including durable goods, fixed investment, and residential investment are all running below average, or the opposite of being significantly above normal levels in both 1972 and 2000. This can also be seen in the Conference Board’s Leading Economic Indicator Index, which while being in an upward trend since late 2023 remains in negative territory. Forward-looking cost-based indicators suggest a higher trajectory for both manufacturing and leading economic indicators over the next year, which would be historically inconsistent with a recession and market top.
No Fed hiking cycle is a positive. Both the nifty fifty and tech bubble periods both coincided with a Fed hiking cycle. In January 1973, the market peaked 3 days prior to the first hike, and the Fed did not cut until December 1974. During the tech bubble, the Fed began hiking rates in June 1999, or about 9 months prior to the market peak. While the Fed continues to be on pause, fed funds futures prices suggest a 0% probability that the Fed hikes by year-end 2026. Odds now show the Fed is 88% likely to cut rates in September, with 2 expected rate cuts this fall.
Market today is cheaper than the tech bubble despite better fundamentals. The S&P 500 at 22x forward twelve-month earnings is ~15% cheaper than the peak of the tech bubble at 25.5x despite having 60% higher profit margins and 10% better ROE. When compared to the 10yr which traded at 15.9x at the height of the tech bubble, equities were 10x turns more expensive vs 1x turn less expensive today. On a justified P/E basis, fundamentals and bond yields would suggest the market today should trade at 24x, or slightly above the current multiple of 22x. Using the same approach would suggest the market should have traded at 19x during the tech bubble, or 33% below the peak.
Market concentration today looks much more aligned with fundamentals. During the tech bubble, the concentration of the top 10 largest stocks at 27% was nearly 2x above its earnings contribution. The expected earnings growth that was priced in failed to materialize. Today, the weight of the top 10 stocks relative to their earnings contribution is much more aligned at 35% and 32%, respectively. While the top 10 stocks in the S&P at 38.3x is above the tech bubble at 34.4x, Tesla at 145x is meaningfully skewing the data. Excluding Tesla, the top 10 today trade at 26.5x, or ~25% below the tech bubble peak despite returns on capital that are >2x higher.
1 Win-Rate: percentage of time the market was higher in noted forward period
The views expressed in this commentary reflect those of Patient Capital Management analysts as of the date of the commentary. Any views expressed are subject to change at any time, and Patient Capital Management disclaims any responsibility to update such views. There is no guarantee that market trends discussed herein will continue. These views are not intended to be a forecast of future events, a guarantee of future results or investment advice. Because investment decisions are based on numerous factors, these views may not be relied upon as an indication of trading intent on behalf of any portfolio.
The information presented should not be considered a recommendation to purchase or sell any security and should not be relied upon as investment advice.
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