- Bill Smead warns that a stock market bubble is set to deflate.
- Rising 10-year Treasury yields will eventually put pressure on growth stocks, Smead argues.
- Smead’s view contrasts with Wall Street’s bullish forecasts for the S&P 500 for 2025.
The continued optimism about high-cap AI stocks leading the S&P 500 makes no sense to Bill Smead.
The market has continued to offer growth stocks and large-caps at historically expensive valuations, all while their main enemies — interest rates on 10-year Treasury notes — have remained high, recently starting to rise. again towards 5%.
The stock market rally “has ignored what has happened to the price of money,” BI Smead, who manages the Smead Value Fund (SMVLX), told BI. The fund has outperformed 99% of its peers over the past 15 years, Morningstar data shows.
“We’ve had rate hikes and the stock market is up 20% years ago,” he continued. “It’s like defying gravity.”
The market cheered for a more dovish Federal Reserve in the second half of 2024, when the central bank cut rates by 100 basis points, or 1%. But while the job market has remained strong and inflation has hovered near 3%, investors are beginning to realize that rates may remain higher than expected. Rates on 10-year Treasuries have gone from 3.6% to 4.6% since September, even as the Fed lowered its benchmark rate as inflation expectations became more worrisome.
Historically, higher rates have not been a friend of the stock market, especially growth stocks, for which investors take a longer-term view. Rising risk-free yields on 10-year Treasuries eventually begin to look more attractive to investors than highly valued growth stocks, and money begins to flow into the fixed-income market.
Stock valuations are really elevated. The S&P 500’s 12-month forward price-to-earnings ratio is 21, and its forward-looking Shiller CAPE ratio is around 37, one of its highest levels ever.
Yardeni Research
Smead, whose firm manages about $7 billion, said the strong growth performance has started a vicious cycle that has further eroded valuation levels. As stocks have done well, they have attracted more money into growth names and the S&P 500, he said, further boosting their performance, again attracting more money.
One way to quantify this excitement is by looking at the percentage of household assets that are now in stocks, he said. At almost 45%, it is at an all-time high.
St. Louis Fed
As for timing, Smead thinks we’re in the early stages of a liberation that will play out over the next few years.
“The punishment will be unbelievable,” Smead said. “The penalty for being on the wrong side of this trade will be very substantial.”
He added: “People are going to lose a lot of money in the stock market over the next 2-3 years.”
Smead’s views are outside the market consensus. Wall Street’s 2025 year-end median price target for the S&P 500 is 6,600, with strategists, on average, predicting returns of more than 11% this year.
But concerns about a short-term correction are starting to grow.
“While we expect equity markets to make further progress over the year as a whole – largely driven by earnings – they are increasingly vulnerable to a correction driven by either further rises in bond yields and/or disappointments in growing economic or earnings data.” Goldman Sachs strategists wrote in a recent note.
Several big names, including GMO co-founder Jeremy Grantham and Research Affiliates co-founder Rob Arnott, also share Smead’s concerns about greater disclosure.
How the market performs in 2025 may depend on how the inflation outlook evolves and how rates react. If they continue on their upward path, it could finally start to put pressure on stocks, as Smead warns.
Michael Kantrowitz, chief US equity strategist at Piper Sandler, argued the same point in a recent client webinar.
“For the foreseeable future, market corrections are more likely to come from higher rates than weaker economic growth,” Kantrowitz said.
