The S&P 500 appears to be riding the wave of yet another investment "mania," potentially setting the stage for a significant correction next year, warns Stifel.
Strategists at the firm have highlighted the index's elevated valuations, as the S&P 500 continues to notch record highs this year, driven by a mix of a rebounding economic outlook, expectations for Federal Reserve rate cuts, and growing enthusiasm around artificial intelligence.
However, the market’s current trajectory mirrors the characteristics of previous financial manias, according to Stifel, drawing parallels to the pandemic stock surge, the dot-com bubble, and even the speculative fervor of the 1920s and late 1800s. The strategists warn that growth stock returns, which have recently outpaced value stocks, are beginning to echo patterns last seen in the lead-up to the 1929 crash.
“When we stripped everything down to the fundamentals, we were left with the same head-shaking response,” the strategists wrote in a note Tuesday. “Even with all the talk of a soft landing and expectations for Fed rate cuts, the fact that the S&P 500 is up nearly 40% year-over-year suggests the market has overshot.”
If the S&P 500 follows the classic arc of previous manias, the strategists project it could surge to around 6,400 before sharply retreating to approximately 4,750 in 2024.
“Sure, we can cherry-pick data like anyone else and apply the highest cyclically adjusted valuation we've seen in the past 35 years, which could imply about 10% more upside. But if we take a longer-term view of previous manias, the same analysis suggests that by 2025, the S&P 500 could be back to where it started in 2024, representing a 26% drop from the prospective peak,” the note explained.
Strategists cautioned that next year could bring a fresh set of challenges for equities, particularly given the uncertain outlook surrounding Fed rate cuts. While the Federal Reserve has hinted at more cuts ahead, there’s also the risk that easing monetary policy too soon could undermine inflation control efforts.
“The conclusion we draw is that if the Fed begins cutting rates in 2025 without a clear recession in place—two token 25 basis point cuts at the end of this year don't count—it would likely be a mistake. Investors could pay the price for this misstep by the latter half of 2025 and into 2026, if history is any guide,” Stifel’s strategists suggested.
They also warned that the impact of a potential market correction could have long-lasting effects. Historically, financial manias have often led to a prolonged period of weak stock returns over the subsequent decade, a pattern that could play out once again.
“Manias are disruptive to capital markets on the downside, just as they are euphoric on the way up,” they added.
Several other analysts on Wall Street have also voiced concerns that stocks may be overvalued at current levels. Yet, overall sentiment among investors remains relatively bullish, especially as many expect the Fed to implement further rate cuts in 2025.
