Editor's note: Don't ignore the market's warning signs... The S&P 500 Index has performed well so far this year despite the Federal Reserve's insistence on keeping interest rates high. But Joel Litman – chief investment strategist for our corporate affiliate Altimetry – believes this bull market is giving investors a false sense of security. Joel says this bullish outlook is the result of tech stocks propping up the broad market. That's why he urges investors to remain aware of the underlying issues in today's market in order to avoid getting too comfortable in this tech-driven bull market. In today's Masters Series, adapted from the March 4 and March 20 issues of the free Altimetry Daily Authority e-letter, Joel discusses the ongoing disconnect between stocks and venture-capital funding... details how tech stocks are driving the market's gains right now... and explains why investors are ignoring the underlying risks in today's market...
Don't Let This Irrational Market Lull You to Sleep By Joel Litman, chief investment strategist, Altimetry Last year started off OK for venture capital ("VC")... VC companies raised almost $45 billion in the first quarter of 2023. That was higher than the $32 billion they raised in the prior quarter... although still way below the $85 billion average from 2021. Then, VC megabank Silicon Valley Bank collapsed in March. Not long after the bank run, VC firm NFX conducted a survey of 870 founders. Nearly 60% said Silicon Valley Bank's collapse would make it tougher to raise funds in an already tight market. And 22% worried they wouldn't be able to raise any funding at all in 2023. Their bearish outlook was right. VC fundraising fell to roughly $31 billion per quarter through the rest of last year. Stocks and VC typically move in tandem... because they tend to thrive in similar environments. From that standpoint, it should come as a surprise that the market did just fine last year. As we'll explain, this disconnect is further proof that investors aren't thinking clearly today. They're treating two very similar investments as if they're completely different...
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When inflation is low, interest rates tend to be low, too... And young companies – like those funded by VC – thrive when they can borrow cheap debt. VC funding reached an all-time high of $345 billion in 2021... before pulling way back to $241 billion in 2022, as the Federal Reserve started raising rates. Like VC, stocks tend to soar when inflation and corporate tax rates are low. With less money going toward costs, taxes included, it leaves more cash to go into investors' pockets. As VC enjoyed a banner year, the S&P 500 was up 27% in 2021. It fell about 20% amid the Fed's rate hikes in 2022. This correlation between VC and stocks is typical... and rational. Two asset classes benefit from similar environments. So they both tend to do well at the same times. Except last year, investors got irrational. The two markets diverged. It's no secret that the S&P 500 had a great 2023... The index was up 24%, spearheaded by the rise of AI and Big Tech giants like Nvidia (NVDA). Following the normal pattern, you'd expect VC startups to have done well in 2023. Yet that couldn't be further from the truth. Around 3,200 startups failed last year, destroying more than $27 billion in venture funding. And this break with tradition is still going strong. Money is rushing out of startups... and into the biggest stocks. While the VC market falls apart at the seams, the S&P 500 has climbed 10% so far this year. And the red-hot "Magnificent Seven" tech stocks account for 45% of those gains. NVDA alone accounts for 15% of the index's gains since 2023. Stocks shouldn't be doing well today. Inflation still hasn't come down to the Fed's target 2% levels. Interest rates are expected to remain high through the remainder of the year. The stock market can't keep rallying blindly... Something has got to give. Clearly, the AI mania is still driving this market optimism. That's a problem for all investors. While AI has contributed to some economic growth over the past year, it's not enough to justify the market's overall bullish outlook... The fact is, there are still economic pressures that have yet to come to the surface. For one, U.S. corporate bankruptcies are piling up. The number hit a 13-year high in 2023 and is expected to keep climbing in 2024. There's also the nation's struggling commercial real estate sector, which is set to be a major source of losses for banks. U.S. office vacancy rates rose to a record 19.6% in the fourth quarter of 2023. We expect a wave of U.S. defaults – likely led by commercial real estate – to land soon. And when it does, investors are going to panic. That's because they're acting as if these very real issues don't exist... We can see this through our aggregate Embedded Expectations Analysis ("EEA") framework. The EEA starts by looking at average stock prices for U.S. companies. From there, we can calculate what the market expects from future cash flows. We then compare that with our own cash-flow projections. In short, it tells us how well U.S. companies have to perform in the future to be worth what the market is paying for them today. As you can see, 2022 was a record year for U.S. companies' profitability. The aggregate Uniform return on assets ("ROA") reached a high of 13%. While the numbers for 2023 aren't yet finalized, it looks like last year's profits will take a bit of a hit... with Uniform ROA expected to fall to about 11%. And yet, the market is already pricing in a rebound, even though the worst is likely still to come... Investors don't see the current risk from today's economic pressures. They're too focused on what's going right in the economy, particularly with AI-driven tech. Meanwhile, they're completely ignoring the warning signs coming out of almost every other industry, particularly in debt-laden areas like commercial real estate. While tech may carry our economy over the long term, it's not strong enough to shield us from waves of default elsewhere. Investors who get too comfortable in this tech-driven market might end up regretting it. Regards, Joel Litman
Editor's note: Although it's critical for investors to avoid getting too comfortable amid this bullish outlook, Joel is excited about a tiny corner of the market that most investors are ignoring right now. According to Joel and Stansberry Research founder Porter Stansberry, a rare setup is forming in stocks that could lead to the biggest moneymaking story of 2024... That's why they're joining forces for an online presentation on Tuesday, March 26, at 10 a.m. Eastern time, to reveal how this market anomaly will play out – and how you can capitalize on it. Click here to learn more... | 
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