Wall Street Hits New Highs: Why Caution Is Still Warranted

Wall Street is on a record-breaking streak, but this euphoria could be put to the test. This week is crucial as it marks the beginning of the major corporate earnings season. Expectations are huge, and the market can’t afford any missteps. In this article, I’ll explain the three key issues to watch, why the current calm in the credit market seems deceptive to me, and why, despite the highs, I believe caution is our best ally.

A quick word before we start

Before diving into the analysis, I just wanted to take a moment to thank Antoine for sending me a magnificent painting. I’m very touched! He has a great sense of proportion, a great sense of proportion, depicting me as a big green Shrek next to his father. I think I’ll remove the Kandinsky from my bookshelf to hang this piece of contemporary neo-realist art. Joking aside (though if you have a spare Picasso from his Blue Period, feel free to send it my way), let’s get down to business.

Earnings Season: Are Expectations Overblown?

This is the heart of the matter. Earnings season is kicking off, and analysts expect a profit increase of over 20% for U.S. stocks. That’s huge. The market is already trading at a very high valuation, which means that any disappointment, no matter how small, could be costly.

The Dow Jones hit an all-time high yesterday, right as we enter this period. If a company announces an increase of 'only' 19%, it could be punished. Even an excellent result doesn’t guarantee a positive stock market reaction. As enthusiasts know, you always need a little more. By the way, this reminds me of a little riddle: how did a company manage to beat analyst expectations, by just one cent, for 20 years? We’ll come back to that.

Credit, a Barometer of Confidence (or Complacency?)

For me, the key barometer of the day is the credit market. Let’s look at high-yield spreads. Basically, this is the rate paid by companies deemed fragile to borrow money. The lower this rate, the more confident the market is about the future.

Today, this rate is around 2.75%. It’s ridiculous. We’re lending money to 'lame ducks' for next to nothing. To give you an idea, this same rate climbed to 11% during the COVID pandemic and approached 20% in 2008. Currently, there’s so much money that everything is getting funded, perhaps even indiscriminately. It reminds me a bit of the dot-com bubble. We know there’s a bubble, but like an inflating balloon, we never know when it’s going to pop.

For now, the market sees no danger. But the slightest tension on this front could be a real warning sign.

Technical Analysis: A Sector Rotation on the Horizon?

When we look at the indexes, we see some interesting dynamics:

• The Dow Jones: It’s at its all-time highs and holding steady. This is a sign of strength. We can feel that investors are turning to 'solid' companies like PepsiCo.
• The Nasdaq: Conversely, it has been stagnating for two months and is hovering near its recent lows. Doubt is creeping into the tech sector. We may have gotten ahead of ourselves, and now the results need to follow.
• The S&P 500: It is advancing, but not with the same vigor as the Dow Jones, held back by its significant tech component.

So, we are observing the beginnings of a rotation: investors seem to be slowly taking profits from tech to reposition themselves in more traditional stocks. Everything now hinges on the results of giants like Nvidia or Meta. If they disappoint, we’re going to feel it.

What about other assets?

• Oil is holding around $70, a zone that seems to suit everyone (the 'gentleman’s agreement').
• Bitcoin has rebounded above 60,000 points, which is positive, but it remains far from its highs after losing nearly 35% in two months.
• In Europe, the CAC 40 and the DAX are also at their peaks, showing that the trend is global.

The Historical Anecdote: When Everything Is Too Perfect

Let’s return to our riddle. In the 1990s, General Electric, under its iconic CEO Jack Welch, impressed everyone. Every quarter, the company would beat analyst expectations, often by just a single cent. A mechanism a little too good to be true…

After the CEO’s departure, doubts arose. The securities regulator investigated and, in 2009, General Electric paid a fine to quietly close the case. The moral of the story? An earnings per share figure that’s a little too perfect always warrants a degree of skepticism.

Conclusion

If I had to sum up the situation in one word, it would be: caution. Records are nice, even extraordinary, but they remain fragile as long as the proof is lacking. And the proof is in the companies' balance sheets. We’re reaching the moment of truth, the time to say: 'Show me the numbers!'.

The credit market is reassuringly calm, suggesting that very smart people see no risk. But even the brightest can be wrong. We are leaving the world of imagination and entering the realm of reality. The real test is now.

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