Is the Stock Market in a Bubble? Don’t Bet on It.

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Sometimes, what you see is what you get. That wasn’t the case with the August payrolls report.

At first glance, the number was a massive disappointment. The U.S. economy added just 235,000 jobs last month, well below the 750,000 consensus and even beneath the lowest estimate of 400,000. The immediate narrative was obvious—growth is slowing, the job market is stagnating, and the recovery just isn’t happening quickly enough.

But dig a little deeper, and all was not as it seemed. The 0.6% month-over-month increase in average hourly earnings pointed to continued inflation, while the upward revisions to June and July employment numbers, which went to 976,000 and 1.1 million, respectively, suggested that perhaps the figures weren’t quite as weak as they looked. That just about no jobs were created in the leisure and hospitality industry indicated that the Covid-19 Delta variant might have been a bit of a problem.

By the end of the day, it didn’t seem to mean all that much as the

S&P 500

closed down 1.52 points on the day, ending the week at 4,535. Still, the jobs report was held up as either a sign of trouble ahead or a signal that there’s nothing to worry about. The numbers could be a reason, in other words, for the Fed to be cautious on the start of tapering or a signal that the central bank should start paring its bond-buying ASAP. “People will find data to support their narrative,” says Hedgeye’s Keith McCullough.

But which narrative? These days, it can feel impossible to choose, which is, I suppose, why Morgan Stanley strategist Mike Wilson laid out two opposing views in a note released this past week. On the one hand, the Fed looks at the incoming data, particularly on inflation and the potential for peaking Delta variant cases, and decides it’s time to taper. Wilson suspects that Jerome Powell & Co. could start the process by winter, and when it does, interest rates would rise, stock valuations would fall, and the market would drop 10%, even though financial shares could benefit.

On the other hand, a growth slowdown could also be in the offing due to sagging consumer confidence and the fact that so much demand has been pulled forward. And if growth surprises too much to the downside, it too could cause the market to finally correct, something that would cause healthcare and consumer-staples stocks to outperform.

“Bottom line, this fall we still expect our midcycle transition to end with a 10%+ S&P 500 correction, but a narrative of either fire or ice will determine the leadership,” Wilson writes. “As such, our recommendation is a barbell of defensive quality with financials to participate and protect in either scenario, which appear equally likely to occur.”

Wilson’s fire-and-ice scenarios end the same way, with a long-overdue correction. That a correction should have happened by now is another narrative being bandied about by investors marveling at the market’s nonstop gains. The S&P 500 rose 2.9% in August, its seventh consecutive monthly advance, just the 15th time this has occurred since 1950. It has also gone all year without a drop of at least 5%, which has happened just twice since 1980—in 1995 and 2017—notes Keith Lerner, chief market strategist for Truist Advisory Services.

That certainly is rare, and there’s no shortage of reasons that the market should drop. It’s been going up too long. It’s too expensive. The Fed is distorting its performance.

DataTrek’s Nicholas Colas offered 10 such rationales, ranging from market seasonality to geopolitical events to a Covid breakout so severe that new lockdowns are needed. He even cites factors that would benefit us in the real world, but not necessarily the market, such as a quicker end to the pandemic. “Today’s list is not a warning to ‘sell everything,’ ” Colas writes. “Rather, it is a (hopefully) comprehensive look at what could go wrong.”

Just because it can go wrong doesn’t mean it will. That’s particularly true because of the strange market dynamics at play.

J.P. Morgan strategist Nikolaos Panigirtzoglou credits retail investors for much of the rally, buying stocks at every dip. But that has pushed equities to levels that has made professional investors, such as pension funds, uncomfortable. Rather than loading up on shares, they’ve bought bonds to keep their asset allocations properly weighted. And when the time comes, they’ll start selling their stocks—and likely their bonds, too—Panigirtzoglou adds.

Still, despite allocations to stocks for non-bank investors that are now nearing the post–Lehman Brothers high, he isn’t predicting a correction just yet. “[In] the absence of a material slowing in the retail flow into equities, the risk of an equity correction remains low,” Panigirtzoglou writes. “Whether the coming Fed policy change changes retail investors’ attitude towards equities remains to be seen.”

Don’t get me wrong. No market goes up forever, and this one could use a breather. In this space at the end of 2020, I pondered whether the stock market was a bubble and concluded it wasn’t, despite runaway special-acquisition vehicles, hot initial public offerings, and parabolic moves in many torrid growth stocks. Now I’m not so sure. But there’s a problem with trying to predict a correction: not getting one. The S&P 500 has had four drops of 3% or more in 2021, but has resumed its advance each time. Selling at the bottom of each would have meant leaving big gains on the table. Rather than trying to perfectly time the exit, I’d listen to the market, which shows no inclination of correcting just yet.

Remember, you can tell the market what to do. It just doesn’t have to listen.

Write to Ben Levisohn at Ben.Levisohn@barrons.com