Stock Market Chaos: This Asset’s Signal on Investor Risk Preferences

The S&P 500 has set 29 new records in 2024, peaking again on Thursday. However, lower futures on Friday suggest it may not reach 30 records in this session.

Optimism about potential interest rate cuts and excitement over AI have driven this bull run. However, caution is advised. The Nasdaq 100’s 14-day relative strength index has surged to 77.5, surpassing the overbought threshold of 70. Additionally, the market is increasingly reliant on a small number of big-cap stocks, which are significantly more expensive than their small-cap counterparts.

Doug Kass, founder of Seabreeze Partners Management, lists several concerns. He believes corporate profit expectations are “unrealistic” and notes that stocks are overvalued relative to Treasury yields. Kass also points to underestimated political risks, overly bullish investor sentiment, and potentially toxic market structures and investor positioning.

Ian Culley, investment analyst at All Star Charts, highlights recent market volatility as evidence of ongoing instability. He suggests monitoring high-yield bonds for insights into investor sentiment. According to Culley, the performance of the iShares iBoxx $ High Yield Corporate Bond ETF compared to the Invesco S&P 500 High Beta ETF and the Invesco S&P 500 Low Volatility ETF provides a clear indication of risk appetite.

“When investors feel comfortable buying high-risk bonds, riskier stocks with a higher beta outperform safer alternatives,” Culley explains. He adds that a breakout of the HYG above 78 would confirm a risk-on stock market rally.