The chase is on.
According to a survey of fund managers, global investors have added exposure to technology stocks at the fastest pace since early 2009.
That same survey revealed the biggest three-month rise in fund manager risk appetite on record.
Those fund flows are helping send both the S&P 500 and Nasdaq to fresh record highs.
Flows are also finding their way into the market’s biggest stocks and driving market valuations to historic levels.
While everyone is getting sucked in by the rally, it’s creating a massive risk for investors.
I know because I’ve been there before.
And I’m seeing the same behavior that preceded another historic collapse in the stock market.
Excessive Valuations
Nvidia (NVDA) recently became the first company to surpass a $4 trillion market valuation. And other companies like Microsoft (MSFT) aren’t far behind in achieving the same milestone.
With swelling market valuations, the largest stocks are grabbing a record share in the S&P 500.
Since the S&P is weighted by market capitalization, stocks with a bigger market value receive a greater share in the index.
Nvidia alone accounts for over 8% of the S&P 500… the largest weight of a single stock in the index since IBM in 1969.
The top 10 stocks in the S&P now make up around 39% of the index. That’s the largest concentration in the top 10 ever.
But as investors push their share prices to new heights, earnings aren’t keeping up.
That means valuations are being sent to nosebleed levels.
Based on expected earnings per share, the 10 largest stocks in the S&P 500 trade at a price-to-earnings (P/E) ratio of nearly 30. That’s even higher than the top 10 P/E ratio during the last massive bubble in tech stocks heading into the internet bust.
I saw what happened when that bubble burst in the early 2000s.
And I can tell you from experience, very few are prepared to navigate the market that I believe lies ahead.
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Conditioned to “Buy the Dip”
Buying at excessive valuations can weigh significantly on long-term returns.
One forecast from asset manager GMO puts the S&P 500’s real return over the next seven years at -4.6%.
Other major banks like Goldman Sachs also forecast below-average returns over the next decade due to the state of valuations.
The bursting of the internet bubble offers an example.
Following the highs made at the top of the bubble in 2000, the S&P 500 fell by 49% in a bear market spanning more than two years.
The S&P wouldn’t make a new record high for seven years. It wasn’t until 2007 that the S&P 500 finally closed above the 2000 peak.
Valuations are a huge risk for investors who have been conditioned to “buy the dip.” The massive run in stocks off the early April lows only reinforces the notion of buying every drop in the stock market.
But just like in 2000, I believe this will eventually end badly.
I had a front-row seat to the chaos after the internet bubble… and I successfully traded through that stretch.
That means there’s still money to be made. But you’ll need a different approach than just buying the dip.
I know how to take advantage of volatility. It doesn’t matter if stocks are falling or rising.
It’s how I’ve generated a 90% win rate for subscribers in my One Ticker Trader advisory this year, despite the volatility we’ve seen.
While a sense of calm has returned to the market, I believe conditions favor a return of volatility… and investors are in for a rude awakening when valuations suddenly matter.
Happy Trading,
Larry Benedict
Editor, Trading With Larry Benedict
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