- US stocks are showing signs of real froth in their valuations, according to Citadel’s Ken Griffin.
- He said stocks are becoming detached from their fundamentals and multiples are very high.
- These are the two catalysts Griffin expects could derail the historic rally in the stock market.
Since the market bottomed on March 23, 2020 amid the COVID-19 pandemic, stocks have done nothing but go up.
That has conditioned investors to buy every dip along the way, as they have been rightly rewarded for taking on more and more risk, Citadel’s Ken Griffin told Andrew Ross Sorkin at the DealBook conference on Wednesday.
And while the buy-the-dip behavior among investors has added great momentum to the markets over the past year, it can also end poorly as stocks begin to detach from their underlying fundamentals, according to Griffin.
“I think [the stock market] is really frothy,” he said, pointing to the volatile moves in high-flying stocks like Tesla.
“Significant stock price moves on relatively small events” represent one sign of market froth, he added, likely referring to Tesla’s near $200 billion market cap increase after it struck a deal with Hertz that was worth just $4 billion.
Griffin outlined two key catalysts that could knock down the current bull market rally as stock multiples hit extreme levels.
“As multiples become incredibly high, any form of either policy error or a company having a bad spell, is going to result in a pretty dramatic repricing of equities,” he explained.
A policy error could come from the Federal Reserve, as strategists have warned that too much tightening from the Fed too early could lead to a decline in stocks. The central bank recently initiated plans to taper its monthly bond purchasing program, though most don’t expect it to raise interest rates until late 2022 or early 2023.
The Fed could also make a policy mistake by not tightening financial conditions and instead letting inflation run too hot, with higher wages leading the way to structural inflation, according to Griffin.
“[The Fed is] going to have to make some pretty tough decisions around both the pace of tapering and the speed with which they raise rates in 2022,” he said.
Meanwhile, a slowdown in growth for mega-cap tech companies facing supply chain constraints or a lack of demand could shock investors and spark a decline in the stock market, he added.