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Is the Stock Market Poised for Crash, Correction or More Gains?

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What You Need to Know

  • David Kelly of JPMorgan Asset Management expects a correction within the next year.
  • Ben Inker of GMO warns that the market is in a speculative bubble that is likely to deflate before long.
  • DoubleLine's Jeffrey Sherman says the biggest risk to the equity market is inflation.

The S&P 500 and Nasdaq hit new record highs Monday, continuing what appears to be a never-ending rally in U.S. stocks. When will the market crash? Is there a correction brewing, or does the rally have room to run?

Year to date, the S&P 500 has gained 14.3% while the Nasdaq and Dow Jones Industrial Average (DJIA) are each up 12.4%. That follows strong gains last year, especially in the Nasdaq, which soared 43.2% despite a raging pandemic.

The S&P 500 gained 16% and the Dow rose 7.3% in 2020. By late 2020, all three major indexes were apparently focused on a future with coronavirus vaccines that could at minimum tame the pandemic and hopefully eradicate it.

The pandemic has been tamed in this country as a result of vaccinations. Sixty-three percent of Americans 12 and older have received shots, but only 54% are fully vaccinated, according to data from the Centers for Disease Control, and the Delta variant, which is more contagious, is spreading here.

Meanwhile, the S&P 500 hasn’t had a 5% correction based on closing prices since the end of October, which makes some market participants jittery. Is the stock market in a bubble verging on bursting, making way for a full-out crash? Is a 5%-10% correction more likely, or, better yet, a continuation of the rally?

ThinkAdvisor asked a number of market experts for their analysis of the current market and their expectations for what happens next. Check out their answers below.

David Kelly, Chief Global Strategist, J.P. Morgan Asset Management:

“The overall U.S. equity market is expensive, with the S&P 500 selling at 21x forward earnings compared to a 16.7x 25-year average.

A correction is likely within the next year. However, it is impossible to say when it will start, when it will trough or how much of a decline we will see. … Because of current relative valuations, mega cap stocks and growth stocks are more vulnerable to such a correction while U.S. value stocks and international stocks should fare better.”

Jeffrey Sherman, Deputy Chief Investment Officer, DoubleLine Funds:

“The U.S. stock market is currently trading at a multiple of 37 on the Cyclically Adjusted Price-to-Earnings ratio. … A level U.S. stocks have exceeded only once in history —1998-2000. … The stock market appears to be rich … [but] when you strip out the top 10 companies by market capitalization, the valuation screens significantly cheaper.

“Given the amount of liquidity within the financial markets, the support from the Federal Reserve and the consumer remaining flush with multiple government stimulus packages and unemployment benefits, it is hard to see a near-term catalyst for a market crash… .

“Historically, market crashes have corresponded to an over-leveraged economy and bond defaults; those risks appear benign given the economy is currently reflating ….The biggest risk to the equity market is inflation. In the next six months we will know whether the recent inflationary data is transitory or the beginning of a higher inflation regime.

“We have witnessed a rotation within the equity market to names that benefit from the reopening of the economy as well as some of the more traditional value names. I believe that this trend will continue over the next 12-24 months as the multiples for these names trade significantly cheaper and continue to benefit as the U.S. returns to some semblance of normalcy.

Stephanie Link, Chief Investment Strategist and Portfolio Manager, Hightower:

“The stock market is not in a bubble, but there are pockets worth paying attention to — Bitcoin and meme stocks, for example. These areas should not deter the other parts of the market where fundamentals matter and are solid.

“The glidepath is higher for the markets given the massive stimulus in place for the rest of this year and into 2022. … Since the Fed’s move is really up to [Chairman Jerome] Powell and he remains firmly dovish, I think the risks are that the economy continues to run hotter, with pockets of inflation as well. … Economically, cyclicals should continue to outperform. Better trend GDP means earnings will continue to move higher — we could see 40% earnings growth this year, 20% next, which is good for risk assets/equities.”

Ben Inker, Head of GMO’s Asset Allocation Team:

“Speculative booms are not guaranteed to end badly but they normally do and that seems to be particularly true in the stock market. We believe the timescale for the eventual deflation of the current speculative bubble is unlikely to be all that long. What form it will take is more difficult to say.

“If the whole of the market is dominated by speculators with outsized expectations, it seems likely that deflation in the obviously speculative tier will take the overall market with it. If those speculators are coexisting with investors who recognize the implications of high valuations on potential returns, the losses may be more contained to the highest fliers.

“Even in that case, the viability of the rest of the market seems to be crucially dependent on the combination of economic growth solid enough to keep corporate profitability strong and not so strong as to reignite inflationary concerns. That is a tightrope that will be far from easy for the market to navigate indefinitely.”

Bob Doll, Chief Investment Officer, Crossmark Global Investments

“Slowly but surely, the Fed will taper and eventually raise rates. At that point, the Fed will become an enemy of the stock market. In the meantime, extraordinary economic and earnings growth is a massive offset. Therefore, it seems as though the market is in a big tug of war. The tiebreaker has been the massive amount of cash sloshing around and the T.I.N.A. (there is no alternative) argument. …

“For now, the path of least resistance is higher, but as economic and earnings growth peak (about now), the market will likely enter a period of choppiness and become directionless. Eventually the business cycle will mature and inflation and higher interest rates will cause multiples to fall, creating a headwind for equities.”

Chris Brightman, Chief Investment Officer, Research Affiliates

“Exuberant retail trading has created localized bubbles — ‘meme’ stocks and electric vehicles come to mind. That said, bubbles can persist longer and go further than any sceptic might expect.

“The U.S. market is priced at a high multiple compared to history, but I wouldn’t label it a bubble, yet. Relative to the negative real yield on 10-year TIPS, the U.S. stock market may provide a respectable excess return of 3% or so. Given today’s paltry starting yields, U.S. stock and bond markets’ long-term returns will likely disappoint.”

Liz Ann Sonders, Chief Investment Strategist, Charles Schwab & Co.:

“Although I think there are many speculation-driven ‘microbubbles’ in the market, I’m hesitant to apply the term to the major averages. These microbubbles — which are largely outside traditional market leadership segments — include meme stocks, no-profitable tech stocks, some SPACs, crypto, among others.

“We have seen bear markets erupt in these from recent highs, with declines of between 20%-50% (more in the case of the meme stocks), without it yet having any meaningful impact on the overall market. That said, sentiment indicators like the put/call ratio and margin debt do suggest heightened market risk to the extent a negative catalyst emerges (candidates might be a monetary policy mistake or something virus-related).”

Larry Swedroe, Director of Research, Buckingham Strategic Wealth:

“I don’t think there’s a bubble. I wouldn’t call it a bubble, because the CAPE 10 (or the cyclically  adjusted price-to-earnings over 10 years) is around 40, to make the math easy. [The CAPE ratio is closer to 37.] So you get a 2.5% earnings yield, but the 10-year TIPS yield is about -0.8%. That’s still an expected risk premium of about 3.5%. Now that’s half of the real expected return gap between stocks and long-term bonds, which has been about 7% over the long term …

“Today, you can expect much less than that, but that’s not a bubble because there’s still a risk premium. I can’t tell you, and neither can anyone else, whether that’s too low a premium or not; there’s still a risk premium. The markets could be saying things that just don’t look very risky, but value stocks are trading at about their historical P/Es. That means with interest rates at zero, their risk premiums are much larger than they’ve been historically.