A famed economist who called the 2008 recession shares 3 ways stocks resemble some of the biggest bubbles in history — and warns 2 ‘bona fide’ recession signals showed up in May’s jobs data

In a few recent client notes, Rosenberg laid out just how historically overextended stocks are — by some measures rivaling some of the biggest bubbles in market history.

Take earnings expectations, for example. Investors expect 17% annualized earnings growth over the next five years as excitement around the potential for AI builds, Rosenberg said. But in the last 100 years, five-year average earnings growth has been just 6%.

Not including 2020, the only time when expectations were higher was at the height of the dot-com bubble, he said.

“The current expectation is nearly triple the norm. So, what we have on our hands is a near-2 standard deviation event,” Rosenberg said in a June 11 note.

He added: “While it would have been impossible, at the peak in early 2000, to tell anyone that the S&P 500 Tech sector would then endure a two-year -80% bear market, that is exactly what ended up happening. There are clear differences between now and then, but the storyline is that all manias end up confronting the classic Bob Farrell rule #1 on mean reversion.”

Another sign the market is out over its skis is the performance divergence between the market cap-weight and the equal-weighted S&P 500 indexes. The standard market cap-weighted index is vastly outperforming the equal-weighted index, indicating that the market’s rally is being driven by a relatively small group of stocks, which Rosenberg said happened in the 2000 and 2008 bubbles. In today’s case, it’s the mega-cap tech stocks known as the Magnificent Seven leading the market.

Third, Rosenberg pointed out the difference in performance between the S&P 500, an index of 500 blue-chip stocks, and the Dow Jones Industrial Average, a smaller index of just 30 stocks, which are intentionally chosen from a variety of sectors to represent the US economy.

The two indexes generally move in lockstep, so inconsistent price action can be a sign of trouble, Rosenberg said. On June 12, the Dow underperformed the S&P 500 by 0.94%, one of only 71 trading days since 1982 where that’s happened, according to Rosenberg’s technical analysis consultant, Walter Murphy. Murphy said 20 of those 71 trading days came in 2000 at the height of the dot-com bubble. Now, it’s only one instance. But Rosenberg says investors should proceed with caution.

“We are living in a world of 1-in-150 events,” Rosenberg said. “The fact that the last time we saw such a massive divergence was back in 2000 surely is cause for pause. The stock market has hit such an extreme in terms of concentration risk that we have Nvidia’s market cap now exceeding the entire FTSE-100 in the U.K. and just three stocks in the S&P 500 (Nvidia, Microsoft, and Apple) represent over 20% of the index.”

In addition to concerning market technicals, fundamentals could also be in a troubling place in the form of labor market weakness, Rosenberg said.

While headline jobs numbers have been generally strong over the last several months — save for April, when the number of jobs added came in well below expectations — Rosenberg pointed to two “bona fide 100%” recession indicators that were triggered in May’s jobs report.

One is that the number of full-time employees is actually falling. Year-over-year, it’s down -0.9%. The chart below shows the number of full-time employees in the US starting to trend downward, as it has in prior recessions.

The second is that the unemployment rate has now risen by more than 0.5% from recent lows, having risen to 4% in May from 3.4% last year.

“The history books back over the past seven decades show that the recession begins when it moves +50 basis points, or higher, from the cycle trough,” he said.

Rosenberg’s views in context

Rosenberg has been calling for a recession and warning of a potential bear market for over a year now. Meanwhile, the US economy has proved to be in a solid place month after month, and stocks have continued to surge.

But some cracks are indeed starting to show in the labor market. For example, job openings are at their lowest levels in three years, and the number of unemployed persons has risen more than 10% year-over-year, according to Piper Sandler.

The US economy is also facing pivotal months ahead as the Federal Reserve deliberates on how to adjust its interest rate policy going forward. Markets are pricing in a couple of rate cuts in 2024. But the Fed has so far been reluctant to lower rates out of fear that it will spark another surge in inflation. If the central bank errs and leaves rates in restrictive territory for too long, however, it risks sending the US economy into turmoil as consumers and businesses pull back on spending and borrowing.

Either way, investors have seen an astounding market rally over the last several months, and future expectations are lofty. How long that can sustain, and just how out of the ordinary things can get, remains to be seen.

“Hopes abound,” Rosenberg said.