Can the S&P 500 continue its rally?
- A strong economy and renewed interest in AI are supporting the stock market.
- Fed rate rises, problems with the Russell 2000, and the narrow scope of the S&P 500 rally are worrying investors.
The stock market is celebrating an anniversary. Four years ago, the S&P 500 began a rally that propelled it up by 117%. It is the third-longest and third-largest bull market since 1947. According to CFRA, if the uptrend continues into a fifth year, the index’s average gain is 21%. This represents significant potential for investors to extend the rally beyond technology companies.
As a rule, bull markets begin when the Fed eases monetary policy, and liquidity flows into risky assets. In 2022, by contrast, the Federal Reserve implemented its most aggressive cycle of rate rises in 40 years; however, this did not prevent the S&P 500 from beginning an upward trend. The reasons lie in the artificial intelligence boom, which has seen companies’ market capitalisation increase by $40 trillion. Nvidia’s shares have risen by an impressive 1,900%, and its market capitalisation is already approaching $6 trillion.
The Fed has now embarked on its next cycle of monetary tightening, whilst interest in artificial intelligence remains high, although it is increasingly being put to the test. According to a Brookings study, for technology companies to justify the colossal investments in AI, they will need to generate $3.5 trillion in profits as early as 2027. This is a staggering figure, and failure to achieve it, coupled with a failed IPO or disruptions within the AI ecosystem, could trigger a sell-off in the S&P 500.
Given the rally’s narrow scope, problems in a single sector risk dragging the entire market down. Indeed, the gap in returns between the standard S&P 500 and the equally weighted indices over the four years of the bull market has exceeded 50 percentage points. Only a third of shares are trading above their 50-day moving averages, down from 70% in mid-August.
Small-cap companies, which are sensitive to the Fed’s monetary policy, are facing serious problems. Around half of the shares of companies in the Russell 2000 are trading 20% or more below their 52-week highs.
For now, the limited scope of the S&P 500 rally and the difficulties faced by small-cap companies are being offset by the AI boom and a strong economy. How long will this last?
Summary: The S&P 500 rally is being supported by a strong economy and the AI boom, but its narrow scope, the weakness of the Russell 2000 and the risk of further Fed rate rises are heightening the threat of a correction.
Author
Alexander Kuptsikevich, a senior market analyst at FxPro, has been with the company since its foundation. From time to time, he gives commentaries on radio and television. He publishes in major economic and socio-political media.
