Here's Why the Stock Rally is Starting to Crack

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Subscribe today wherever you get your podcasts. I'm Stephen Carroll and this is Here's Why, where we take one new story and explain it in just a few minutes with our experts here at Bloomberg. All time highs on the S&P 500. The Dow Jones industrial average up more than 70 points or two tenths of a percent. That's a record high. The S&P 500 up almost 30 points or four tenths of one percent. That's a record high. The NASDAQ composite up about 160 points or seven tenths of one percent. That is also a record high. Everything is awesome. It's interesting to see the momentum continuing to the upside. A lot of reason for us to be very bullish on U.S. equities in this moment. The concern of the market is being sort of a bubble. We understand the excitement about the hyperscaler, but if you look outside of the hyperscaler life in industrial America isn't great. For months the story on stock markets has been one of record high after record high. The S&P 500 had its best September in 15 years. Surprisingly positive economic data, lower interest rates and the rush into artificial intelligence have all helped repeatedly push indexes to new heights. But for all the screaming optimism there are also quieter concerns that shares may have risen too high, too fast. Here's why the stock market rally is starting to show cracks. Our Market Slive managing editor Christine Aquino joins me now for more. Christine, can you first of all put this rally in context for us? In terms of what we've seen up until the end of September, how big has it been? Well Steven, I mean it has been a blockbuster year for U.S. stocks that cannot be denied. As you mentioned record high after record high, we've seen 29 closing record highs actually for this year. The S&P 500 is up 14% this year, so that is set for its third straight annual gain. And historically speaking, the fourth quarter also boasts well for this index. It has gained in this period for all but one year in the past decade, and most signs are pointing to another finish in the green for this index for the end of this year. Now we've talked before about how the calendar months of the year can give us trends for markets, but this has been going on longer than just the good month of September. What are the key factors that have driven this rally? Well obviously big tech is of course still a major driver of the gains of the S&P 500 and given that a lot of those advances that we've seen this year very much concentrated in the stocks that belong to the Magnificent 7 Club. But you know I was looking at it and really what we've seen is a broadening of this rally particularly since April. Some measures of market breadth has significantly improved since then and really when you look at the year as a whole, all major sectors in the S&P 500 are in the green. And so you know tech of course contributing the most gains but everything else is firing on all cylinders. So then what are the signs that investors are starting to worry about? Well you know we look at typically positioning in the options market for this sort of sign of caution among investors and there are some you know. If you look at for instance the VIX index which is what we call the fear gauge of the S&P 500. It is still near the year's lows but we are seeing some pockets of caution cropping up like very recently we've seen for instance a single trade paying about 12.5 million dollars to protect against a doubling in the VIX which is you know it's one of these outlier scenarios that probably won't unfold when you think about probabilities but it's something that people are starting to think about as a scenario that is worth paying attention to at the very least. So how widely held then could we say these concerns are? At the moment it doesn't seem like anyone in particular is very much in a mood to sell the S&P 500 outright and so it really is just more about what we're seeing in the options markets and how people are kind of hedging against that risk even as they're still buying the index outright. And so these really are kind of where you look for the initial signs of that sort of caution of course given the way that the index the S&P 500 has moved recently doesn't seem like anyone's happy to sell but they're also starting to think about protecting their long positions currently when it comes to investor positioning. We love getting a bit of history from you as well when we talk to you Christine what have the past rallies and stock markets taught us about how they end typically? Yeah you know when we look at the boom and bust cycles in the past 10 years in the equity markets right the end rallies have typically been brought on by two kinds of things right so one is kind of a sudden acute shock that tends to catch markets off guard either because they were poorly positioned for it or they didn't quite know how to position for it in the first place so I'm talking about for instance the Volmageddon incident in 2018 where a lot of investors were kind of caught in these short volatility structured products that were pretty complex financial instruments that perhaps maybe investors were ill prepared to be positioning in and then of course we had the COVID pandemic in 2020 which was something that kind of seemingly really took markets off guard and then of course more recently we had the US tariff unveiling in April now this was well flagged of course but I think it was just one of these sort of events where investors didn't necessarily prepare for before him just because they didn't have the details they didn't have the information up until it was unveiled. So then what kind of data point or event should we be watching out for that could provoke a reversal in stocks this time around? Well I think what we're seeing at the moment is a foundation for caution being laid out primarily because of data that we've seen when it comes to a weaker US labor market that's something that's kind of been playing out for months now Fed Chair Jerome Powell has warned about it in his recent commentary as have his colleagues on the Federal Reserve and that's something that markets are coming to accept at this point right but that's not necessarily something that could provoke a sudden decline in stocks. What it is doing is just kind of laying the groundwork for a bit more caution as what we're seeing now. Now what could potentially turn that into a sudden pullback is something else that introduces that sudden shock that we were talking about earlier right and this in this particular moment the government shut down in the US has potential to do that if it's something that lasts beyond what investors are anticipating that could potentially provide a spark for that sudden downturn because all of a sudden you have a weaker labor market narrative combining with a longer than expected shutdown. Yeah the so-called black swans on markets things always to watch out for Christine great to talk to you. Christine Aquino our managing editor for Markets Live. For more explanations like this from our team of 3,000 journalists and analysts around the world go to bloomberg.com/explaners I'm Stephen Carroll this is Here's Why I'll be back next week with more thanks for listening. 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