Everything's Expensive in Stocks Now Vulnerable to Lockstep Pain

Updated on
  • Fear of missing out turns to fear of being last one to exit
  • Hard to find bargains as valuations expanded across board

When one industry goes down, another takes over. That was the story of 2017, a year in which the U.S. stock market was almost completely immune to major selloffs.

Could that change in 2018? One month in and the first real rout of the year was different: a concerted pullback. Tech shares were dragged down by Apple, health-care was hit by an Amazon-led foray into the industry and energy shares slid with crude prices.

Case Study: 2017 vs 2018

Equity rotation, which saved the market from tech rout in June, absent in latest selloff

Source: Bloomberg

Stock Performance (%)

This time, nothing was there to offset the loss. With 10-year Treasury yields marching toward 3 percent, a handful of financial stocks that reliably provided last year’s counterbalance were nowhere to be found. The end result: the worst decline in eight months.

Sure, the S&P 500 is still up almost 6 percent in January and stocks were bouncing back Wednesday. But the nature of the selloff highlights what may be a psychological shift, namely, that fear of missing out becomes fear of being the last one to exit. Particularly with everyone from Goldman Sachs to Renaissance Technologies calling a correction overdue.

“Equities are no longer a one-way trade,” said Chris Harvey, Wells Fargo & Co.’s head of equity strategy.

Little is cheap in the U.S. equity market. Stocks have become so harmonized in terms of elevated valuations that relying on rotations to bail out the benchmarks is getting tough. According to data compiled by Bloomberg, a measure of how much price-earnings ratios among the 50 biggest companies vary has fallen to almost the lowest on record.

While overall market multiples trail periods during the dot-com era, a recent study by Leuthold Group showed bargains are actually harder to find now. On the eve of the internet bubble bursting in 2000, 90 percent of the market cap deciles traded at or below historic levels. Right now, none make the cut.

Source: Leuthold

Gaps in valuations have shrunk as investors shifted money among stocks, driving price-to-earnings ratios higher across the board. Blame it on easy money, which has encouraged investors to seek risk in every corner, according to Barry Bannister, chief equity strategist at Stifel Nicolaus & Co. A growing focus on central banks withdrawing stimulus may spur a 5 percent selloff in stocks during the first quarter, he said.

“This bubble is central bank repressed cost of capital for all, which has made ‘all’ too expensive,” said Bannister, “That’s why central banks scaling back in unison is bearish.”

None of this means the market is doomed. One area of particular strength has emerged from consumer-discretionary stocks. Thanks to tax cuts and a pickup in consumer spending, the group has led the market this year and at least two Wall Street strategists raised their ratings for the industry.

To Wells Fargo’s Harvey, financial shares hold the key for the market as the main beneficiary of rising yields. He currently expects the market’s loss to be capped at 3 percent. The S&P 500 dropped 1.8 percent over Monday and Tuesday.

 “Financials are the battleground sector,” he said. “If financials crack today or tomorrow because investors begin to sell short-term outperformers or Treasuries catch a bid from risk aversion, we would need to widen our selloff range.”

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