Why the Stock Market Deserves Greater Caution
Regular readers of Secure Retirement reports won’t be surprised by the material in this report. I’m writing it for a broader audience, to answer one question: “How would I warn a typical investor about today’s market?”
Here’s what I would say: Stocks today are approaching extremes rarely seen outside particularly troubled times. A handful of AI-related mega-tech companies are continuing to gain while much of the stock market languishes. This form of concentration has rarely been seen in market history, and has never ended well. Here’s a more detailed answer:
The stock market’s headline performance is providing more reassurance than its underlying condition appears to justify. An index approaching its highs ordinarily suggests that investors see improving prospects for corporate earnings and economic growth. But when most of the companies within that index are struggling, while a relatively small group of enormous companies keeps it elevated, the message becomes considerably less reassuring. That divergence does not tell us when the market will fall, but it does suggest that investors should be more careful about how much risk they are accepting.
The concern today is the combination of weak participation beneath the surface, leadership heavily dependent on enthusiasm for artificial intelligence, and substantial uncertainty in the bond market that stocks appear to be taking relatively lightly. Each condition can persist without producing a major decline. Together, however, they leave the market more vulnerable to disappointment than the headline averages suggest.
Most stocks are telling a
different story
Recent research reveals that roughly 60% of S&P 500 companies are trading below their 200-day moving averages, while approximately 75% are below their 50-day averages. These averages smooth daily price movements and help show whether a stock’s recent direction is strengthening or weakening. Falling below them does not establish that a company is in financial trouble, but weakness across so many companies is difficult to reconcile with the impression of a healthy, broadly advancing market.
The explanation lies partly in how the S&P 500 is constructed. Companies with larger market values exert more influence on the index. A strong advance in a few enormous companies can therefore outweigh declines across hundreds of smaller constituents. Investors may own a fund containing approximately 500 companies and still find that its performance depends disproportionately on a handful of businesses exposed to similar expectations.
An equal-weight index, which gives each constituent approximately the same importance, offers another perspective. Looking at recent results shows prolonged deterioration in equal-weight performance relative to the conventional S&P 500. That is evidence that the typical company has been losing ground relative to the largest companies, even while the headline index remains strong.
This matters because broad participation gives a rising market more sources of support. When leadership narrows, disappointing results from a few dominant companies can have an unusually large impact. The market becomes increasingly dependent on those leaders continuing to deliver both strong business results and results strong enough to satisfy already optimistic investors.
AI can succeed while investors lose money
Artificial intelligence may produce substantial economic benefits, and some leading companies may ultimately earn exceptional profits from it. Neither possibility guarantees that their stocks are attractive at every price. A transformative technology and a rewarding investment are related questions, but the answer to one does not settle the other.
For investors, the issue is how much future success has already been incorporated into share prices. If prices assume years of rapid growth, heavy spending must eventually generate sufficient profits to justify those expectations. Slower adoption, disappointing returns on investment, stronger competition, or pressure on profit margins could lead investors to reconsider valuations even if AI continues to improve.
Concentrated leadership also creates the possibility that apparently different investments will react to the same disappointment. Technology companies, equipment suppliers, and businesses supplying infrastructure may all benefit from the same spending cycle. Owning several such businesses can provide less diversification than their different names and products suggest.
The bond market deserves attention
The MOVE Index measures volatility, or uncertainty, in the Treasury bond market. At 114, the MOVE Index indicates elevated anxiety in the bond market, although it remains below levels associated with the most severe financial crises.
Similarly, the VIX measures volatility in the stock market over the next month. At a low 15, the market is saying stocks will continue to have low volatility, or be “safe.” Neither measure predicts the direction of prices.
The readings suggest that interest-rate markets are pricing considerable uncertainty while stock-index options reflect comparatively restrained expectations for near-term turbulence. Their numerical levels are not directly comparable because the indexes measure different things. Nevertheless, the contrast deserves attention because interest rates influence corporate borrowing costs, the appeal of competing investments, and the value investors assign to future earnings.
If yields rise materially, companies may face more expensive financing while investors demand better prospective returns from stocks. If yields fall because the economy is weakening, lower rates may be accompanied by disappointing earnings. The reason rates move matters as much as their direction; a bond-market rally is not automatically good news for stocks.
A high MOVE-to-VIX ratio should not be treated as proof that equity volatility must surge. The gap could narrow because bond volatility subsides, stock volatility rises, or both occur. The warning is that calm in stock-index options does not establish calm throughout the financial system.
A warning deserves a response even without a deadline
Historical comparisons can illustrate how financial stress spreads, but they cannot establish that today will repeat 2000, 2007, 2018, or 2022. Narrow leadership can persist, and markets can become healthier if earnings improve across more industries and previously lagging stocks begin to recover. Stronger participation, more stable financing conditions, and evidence that AI spending is producing durable profits would all weaken the bearish case.
The less favorable possibility is that the leading stocks lose their ability to offset weakness elsewhere. The catalyst could be an earnings disappointment, a change in interest-rate expectations, or growing doubts about the profitability of the investment boom. We do not need to identify the precise trigger to recognize the vulnerability.
For retired investors, this calls for reviewing concentrated exposures, maintaining adequate liquid reserves, and deciding how much decline a portfolio can withstand before a difficult market forces an unwanted decision. Increasing caution may mean accepting smaller gains if the rally continues. That is a real cost, but it should be weighed against the consequences of a substantial loss when withdrawals must continue.
The market may continue rising. What deserves skepticism is the assumption that an index near its highs proves the risks are low. When most stocks are weakening and a few leaders carry an increasing share of the burden, preserving the ability to act later becomes more valuable. We should remain open to improving evidence while taking the present warning seriously.