The Zhitong Finance App learned that despite the recent correction, the S&P 500 index and the Nasdaq 100 index are still close to record highs. According to bulls, US stocks are expected to experience a round of upward trend before the end of the year, as they have been used to for many years. However, some analysts believe that the sell-off in US stocks is not over yet, and may have just begun.
Bulls are still looking forward to the year-end market
In the bullish scenario of the bulls, oil prices will fall in some way before the end of the year, weakening market expectations for the Federal Reserve's interest rate hike in 2027; 10-year US Treasury yields will fall to 5% or below in some way; and profit growth momentum will continue, especially artificial intelligence (AI) transactions. All of these factors will drive US stocks to close to record highs at the end of the year, and the S&P 500 index will reach or exceed 8,000 points.
Wall Street institutions also have many watchers. As technology stocks continue to weigh on recent days and dampen investor sentiment, The Kobeissi Letter, a well-known financial research institution on Wall Street, bucked the trend and threw a bullish view. A recent report released by the agency shows that the US stock market benchmark index is still high, but the valuation has “gone through the winter.”
Analysts at The Kobeissi Letter believe that US stocks are experiencing a “hidden bear market,” which represents “one of the biggest opportunities in the market today.” The agency's judgment mainly comes from valuation multiplier compression. Energy inflation, US bond yields, and interest rate hikes have weighed down the valuations the market is willing to pay; if these pressures ease and profits continue to be realized, technology stocks led by the “Big Seven” may usher in a strong valuation repair.
Although the benchmark stock index is close to record highs, The Kobeissi Letter believes that the stock valuations of some technology companies that are far ahead of market benchmarks in terms of fundamentals have reflected significant and unreasonable valuation discounts.
For example, Nvidia's stock price has risen 21% in the past 12 months, but its price-earnings ratio has declined 46%; the current forward price-earnings ratio is about 24 times, close to 22 times that of the S&P 500. Speaking about Nvidia, the analyst said, “Even though profit growth was extremely strong during this period and analysts' expectations rose, driving the stock price to rise sharply by 21% and the market capitalization stabilized at the $5 trillion super mark, the company's price-earnings ratio fell sharply by 46%.”
The agency also said that the forward price-earnings ratio of the S&P 500 information technology sector and the S&P 500 overall index is now almost the same — this is very rare, and historically, technology stocks “have almost always enjoyed significant valuation premiums over the broader market.” As a result, the agency believes that this valuation compression has formed a “hidden bear market” and is depressing the overall stock valuations of the world's largest tech giants.
The agency's team of senior analysts wrote, “If this background is eventually no longer included in market pricing, it could catalyze another sharp rise in the S&P 500 index, where tech giants hold about 40% of the weight.” They added: “If the coverage of the rise only expands slightly, the buying power will also increase rapidly.”
The Goldman Sachs capital flow team provided another bullish clue — the reopening of corporate repurchase windows, inflows of retail capital at the end of the year, and foreign purchases after the election may bring incremental demand for stocks with reduced valuations. Regarding AI semiconductor assets that were previously concentrated and drastically reduced, the Goldman Sachs analyst team emphasized that the new purchases do not have to be huge; they may also drive a significant price recovery. However, this support first affects the overall market. Which companies will eventually flow to on a large scale still depends on which companies can provide new evidence of profit growth in this round of financial reports, and AI computing power-related semiconductor stocks and cloud computing leaders may have an advantage.
The two point in common is that high-quality technology-based growth assets that can continue to be strongly realized with profits are expected to be promoted by capital return and valuation repair at the same time.
The sell-off may have just begun
However, in the view of more cautious investors, the possibility that the bullish scenario listed by the bulls will occur is very low, and the current pullback in US stocks is likely to evolve into a deeper adjustment.
First, the impact of energy-driven inflation may be difficult to overcome. Analysts pointed out that the direct trigger for the sell-off that began on October 14 was the market's reaction to the US CPI report for September, which exceeded expectations. Given that core inflation remains high and is still rising, the Federal Reserve must remain alert, take initiatives, and tighten policy interest rates more aggressively. The market is also beginning to take into account the possibility that the Fed will adopt a more aggressive interest rate hike cycle in 2027.
Soaring energy prices are the biggest driver of increased inflationary pressure in the US. Although the bulls hope that oil prices will fall before the end of the year, this is unlikely to happen. Because the tension in the Middle East is escalating — the flames of war have spread from the Strait of Hormuz to around the Strait of Mander and may disrupt Middle East oil supply, which has recently shown signs of recovery. Coupled with the fact that the global oil inventory buffer is being continuously consumed, all of this indicates that oil prices may rise further after the US midterm elections, and even trigger an energy price shock similar to that of 1974. Obviously, this will force the Federal Reserve to take a more aggressive interest rate hike.
Second, the sell-off in the global bond market is likely to continue. Investors are aware that Western countries are still continuing fiscal stimulus policies in the post-pandemic era, but today the US, France, Japan, and many others have unsustainable debt levels. But the US, or the rest of the countries affected, are unwilling to cut spending or increase taxes. As a result, the sell-off in global bond markets is likely to continue.
Long-term bonds aren't even too worried about rising oil prices — the rise in US 10-year Treasury yields is mostly driven by rising real yields. The break-even inflation rate of inflation-protected bonds remains stable, indicating that investors expect the energy shock to be temporary. The risk, therefore, is that bond investors may be underestimating inflation caused by rising energy prices and sticky core inflation. This means that nominal yields are likely to rise further as inflation expectations rise.
Furthermore, the AI narrative that has supported the rise in US stocks over the past few years seems to have shown signs of the bubble bursting. Concerns about the sustainability of AI financing transactions and whether investing huge amounts of computing power will eventually generate sufficient revenue and cash flow continue to ferment. Compared to its all-time high in June, the Philadelphia Semiconductor Index has fallen by more than 20% and has fallen into a bear market.
As concerns about inflationary pressure and fiscal conditions push up US bond yields, the era of cheap capital experienced in the first nine months of this year is beginning to disappear. Luis Alvarado, co-head of global fixed income strategy at Wells Fargo Investment Research Institute, said that although investors were once excited to participate in the AI boom, market sentiment has begun to change, and now investors are demanding higher risk compensation.
Analysts pointed out that AI infrastructure actually sells two types of products: 1) AI output tokens; 2) AI workflow processing capabilities, and the latter can be measured by GPU rental prices. However, due to increased competition in the market, the export token price has collapsed drastically (as measured by the LLM Spending Index). As a result, as token products are increasingly commercialized, it will be difficult to achieve profits, and this mainly affects OpenAI and Anthropic, and affects many companies in the two AI giant chains.
The adoption of AI is also not progressing well. Currently, it seems that companies that use AI are not receiving corresponding financial benefits from AI applications — and this is where the “pain point” of AI transactions lies. As a result, the bursting of the AI bubble is likely to continue to evolve. Currently, this process is gradual and selective, but it is likely to accelerate.
Overall, if the bullish scenario expected by the bulls occurs, then the year-end market for US stocks is indeed worth looking forward to. However, from a fundamental point of view, these bullish scenarios are unlikely to occur. As a result, the current sell-off is likely to continue and worsen further as the AI bubble bursts.
The key question is, could this be the start of the next bear market? If high inflation forces the Federal Reserve to reverse the yield curve and trigger an economic recession and a reduction in AI capital expenditure, then the answer to this question will be yes.