• US stock indices sail towards successive record highs

• Hawkish Fed doesn’t scare bulls as volatility remains inexistent

• Valuations are historically stretched but earnings keep growing

High after high

All major US indices are having an astonishing year, recording consecutive all-time highs as the economy seems more and more likely to achieve a soft-landing. It has been more than 20 months now since the stock market experienced a sizable correction, but the bulls appear unhindered.

Lately, stocks seem to have found a way to rally even in cases where data suggests otherwise. Such an incident was the market's reaction on Wednesday, when stocks finished the session significantly higher despite a hawkish FOMC meeting. The updated dot plot indicated one rate cut for the year, down from three in its previous version, which is considered bad news for risk-sensitive assets.

It could be argued that the downside surprise in inflation data earlier in the day could justify those gains, but equities were also advancing ahead of the event, even after the stronger NFP on Friday had tilted risks to the hawkish side. In any case, the rally looks bulletproof given that US Treasury yields are higher compared to the start of the year, while market pricing has shifted from six to almost two rate cuts at the moment of writing.

What can stand in its way?

The relentless rally to uncharted waters would be expected to increase volatility in the equity world, but surprisingly this has not been the case. On the contrary, the CBOE Volatility Index (VIX), Wall Street’s fear gauge, has been hovering near four-year lows despite the consecutive record highs, suggesting that investors have not been actively positioning for a pullback.

This phenomenon could be explained by the fact that every recent attempt for a downside correction has been shuttered, leading to severe losses for the bears. At the same time, it is not common for the US stock market to decline ahead of elections. Hence, the major risk moving forward is an exogenous event that could derail the rate-cut process and spoil the soft-landing scenario.

Valuations are rosy but earnings keep growing

This year’s rally has pushed major stock indices to ‘expensive’ territories not only from a price perspective but also relative to the value they are offering. Currently, the S&P 500 is trading at 20.7 times what analysts project earnings to be over the next twelve months, multiples only seen during the pandemic and dot-com bubble.

On the one hand, valuations so stretched should ring alarm bells over an impending correction. However, for now, it seems that investors have been attributing them to corporate earnings constantly beating expectations and the AI frenzy. Meanwhile, higher multiples could be also partially justified by the increasing weighting of tech stocks in US indices.