ClearBridge warns record margin debt and $1 trillion daily 0DTE options make the market overdue for a correction. Extreme valuations leave no margin for error, the firm says.
ClearBridge Investments warned that the second quarter's technology-driven rally has built up leverage across the stock market to levels that make a speculative washout likely. Record margin debt and surging zero-day options volume are two signs of the buildup. Extreme valuations leave the market with little margin for error, the fund manager said.
Margin debt balances rose 50% from a year ago to an all-time high, according to FINRA. Zero-day-to-expiration options now account for 28% of all U.S. options volume, up from 18% three years ago. Daily notional trading in 0DTE options exceeds $1 trillion. Leveraged ETFs generate 13% of all ETF trading volume despite holding only 2% of total ETF assets.
The ratio of equity market cap to GDP stands at 230%, more than three standard deviations above the long-term average. Profit margins are at record highs. Valuations imply expectations for future growth that are extremely elevated, ClearBridge said.
Other risks percolate beneath the surface. Technology component shortages are challenging the assumption that tech advancement is inherently deflationary, keeping inflation elevated. The U.S.-Iran ceasefire is tenuous, leaving energy markets subject to renewed volatility. Short rates are rising. The yield curve is flattening. The market is pricing in a rate hike. The midterm elections could pull AI further into political debate.
ClearBridge's Appreciation Strategy underperformed the S&P 500 in the second quarter. The biggest relative contributors were ASML, Palo Alto Networks, ASM International, an underweight to Microsoft and not owning Palantir. The biggest detractors were Netflix and underweights to Micron Technology and Advanced Micro Devices. Not owning Intel and Applied Materials also hurt returns.
ClearBridge's underweight in Microsoft (Alpha Score 58) and decision to avoid Palantir (Alpha Score 44) contributed to relative returns, while Netflix (Alpha Score 44) was a detractor.
The team initiated new positions in SpaceX, Micron Technology, Cisco Systems, Advanced Micro Devices, Texas Instruments and Diamondback Energy. It exited Roblox, Boston Scientific, AbbVie and Solstice Advanced Materials. It also received shares of Honeywell Aerospace following its spinoff from Honeywell International.
ClearBridge said it views the current herd mentality as evidence of a market overdue for a speculative washout. The firm does not see recession risk given ongoing economic momentum and sustained tech capex. A correction, even a sharp one, would be healthy for the bull market's durability, the firm said.
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