Wall St banks sound caution on US stocks rally

Some Wall Street banks are sounding caution on the US stock rally, warning that stretched valuations have made equities more vulnerable to declines.

The S&P 500 pulled back for the week though it is up more than 13% since the year began, fuelled by signs of moderating inflation, excitement over advances in artificial intelligence and growing appetite for risk.

Those gains, however, have driven equities to more expensive levels. The S&P 500 now trades at 19 times its expected 12-months earnings, well above its historic average of 15.6 times, Refinitiv Datastream showed.

Similar valuation levels have preceded periods of rocky performance. Historically, the S&P 500 has experienced a median drawdown of 14% over the next 12 months when valuations stand at current levels or above, compared with a 5% drawdown over a typical 12-month period, Goldman Sachs said.

“With valuations now pushing the outer limits of what we would think would be reasonable. ... We would be taking some chips off the table,” said Sameer Samana, Senior Global Market Strategist at Wells Fargo Investment Institute (WFII).

Catalysts that could cloud the outlook include unexpected weakness in economic growth, the potential for the Federal Reserve to be more hawkish than markets have priced in, and a rebound in inflation, investors said.

WFII recently downgraded the technology sector, which has led this year’s S&P 500 rally, to “neutral” from “favourable,” citing “unattractive” valuations.

Goldman urged investors to consider “downside protection” to their stock portfolios, though they expect the S&P 500 to reach 4,500 by year-end, or about 3.5% above current levels.

Published in The Express Tribune, June 25^th, 2023.

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