Reasons to Question the Stock Market Rally

The recent surge in the stock market has sparked optimism among investors. However, David Rosenberg from Rosenberg Research presents three compelling reasons to be cautious about the rally.

Earnings Concerns

While third-quarter earnings have been relatively strong, future guidance paints a different picture. Fourth-quarter earnings per share estimates have declined by 4%, with downgrades affecting eight out of eleven sectors. A significant 64% of the 75 companies that provided guidance issued pessimistic forecasts. This divergence between current performance and future expectations raises doubts about the sustainability of the market rally.

Suspected Influence of Short Covering

Contrary to what one might assume, the stocks driving the rally are not the ones with solid fundamentals. Rather, they are primarily the most shorted stocks and those with weak balance sheets, often dubbed as "non-profitable tech" by Rosenberg. This pattern suggests that the rally might be driven more by technical factors and complacency rather than genuine strength. Hence, caution is warranted.

Lack of Participation by Small-Cap Stocks

Another concerning sign is the lack of participation by small-cap stocks in the rally. The Russell 2000 index has experienced two consecutive days of decline. Though monthly returns appear satisfactory with a 4.3% increase, they are still down 1.6% for the year, significantly lagging behind the S&P 500's 14% and the Nasdaq's impressive 30.3% gain. This 32 percentage-point gap between the Nasdaq and the Russell is strikingly reminiscent of the lead-up to the Dot-Com bubble, raising red flags for Rosenberg.

While Rosenberg's views tend to lean towards bearish sentiment, his arguments highlight important aspects to consider. It serves as a reminder that short-term momentum does not guarantee sustained growth in the market.

By Ben Levisohn