Video Update: Don’t Believe The Hype About This Red-Hot Market Rally

The S&P 500 market rally that started in November has everyone excited.

But in today’s weekly update, Chief Analyst Adam Galas shows just how overvalued the S&P 500 has become, and why a market correction is on its way.

Adam also shares how your Fortress Portfolio is prepared for the shift that’s about to take place so that you don’t have to have a care in the world this holiday season.

Click below to watch the video or scroll down to read the transcript.

Happy SWAN (sleep well at night) investing,

Brad ThomasEditor, Fortress Portfolio

Welcome Fortress Portfolio members to the last video until January 10.

 Now, in this special video update, we're going to talk about the red-hot market rally and why it's super silly.

And I want to inoculate you against the crazy and stupid things that might be coming in the next few weeks.

(Source: The Daily Shot)

Because as you can see, the market has just completed a six-week winning streak.

And with inflation data coming in – which we'll talk about in a moment – and the Fed’s decision on Wednesday, it's possible we get a seventh straight rally.

So, what is going on here? Well, for one thing, long-term rates have fallen by nearly 1% in the last six weeks.

So, the key to this rally is what Bloomberg has been calling “the immaculate disinflation.”

That means that inflation is expected to come down rapidly. The Fed is going to start cutting rates no less than five times next year, but there's not going to be a recession.

In fact, earnings aren't going to just grow at their average rate of 6–8%.

Earnings are going to boom by 11%. And what's more? Thanks to the optimism of AI and obesity drugs, investors are going to pay as much as 22X earnings for stocks.

This is the best-case scenario under Ed Yardeni’s “roaring 2020s” scenario in which he thinks the S&P could potentially soar as high as 6000 within two years.

And remember, this is the most bullish estimate.

Now, is any of this actually possible? Theoretically, yes.

(Source: Truist Advisory Services via The Daily Shot)

The reason is because, as you can see, the market has become extremely concentrated.

In fact, 32% of the S&P is now just in the top ten names, which is a level of concentration not seen for 43 years.

So theoretically, if the Magnificent Seven just keep blowing out earnings over and over and become 40–60% of the market, then even if the economy slows to a crawl and everyone else doesn't grow, nothing else is going to matter.

(Source: FactSet)

Because, of course, the S&P now is 32% Apple, Microsoft, Amazon, Nvidia, Google, Facebook, Tesla, Berkshire, UnitedHealth, and Eli Lilly–one of those companies with the obesity drugs.

(Source: FactSet)(Click here to expand image)

But here's the problem with that thesis: As you can see, the market–even with that 11% growth estimate factored in–is still 13% historically overvalued compared to the historical 10-, 25-, and 50-year PE of 16.9.

In the short term, as I explained last week, valuation means nothing. It's just 5% of returns in any given year.

This is why, for example, stocks are trading at 23X earnings. There was insane valuation on January 4th, 2022, right before they fell 28% in the bear market of 2022. And no one could say that was the peak.

All we can say right now with 90% statistical probability is that from current levels–assuming there is no recession over the next decade–returns will be 1.2% lower annually compared to if the market was fairly valued.

Basically, this is a rally of hopium, the victory of hope over experience.

Now, what about the economy?

Didn't we just have an inflation report and a jobs report that are both very important? Yes, we did.

(Source: FactSet)(Click here to expand image)

And as you can see, the jobs report–like it's been since most of the pandemic–came in slightly hotter than expected, about 20,000 extra jobs.

And unemployment coming in 0.2% lower than expected at 3.7%.

And for context, over the last 50 years, including recessions, the average unemployment rate is 5.8%.

So, this is still close to the best job market in 54 years. But the key for immaculate disinflation is that inflation has to be coming down really quickly.

So, let's take a look at the data.

(Source: Truflation)

As you can see, based on Truflation–which is 97% correlated with the consumer price index (CPI)–and 10 million data points updated daily, inflation is in fact 3.1%.

It bottomed at 2%, has come up, and is now stuck.

But, of course, the Fed doesn't really care about CPI and Truflation.

So, what does the Fed care about? Core PCE. That's the official Fed metric.

(Source: Cleveland Fed)

The Cleveland Fed's own model updates daily and releases the core PCE data on the last Friday of month. This inflation tracker estimates core PCE inflation will come in at 3.5% at the end of December and 3.4% at the end of January.

But most importantly, the annualized data is going to be coming in at 3.7%.

Well, it doesn't take a Ph.D. in calculus to know that 3.4–3.7% is higher than 2%.

(Source: CME Fed probabilities via CME group)

So, what does this actually mean? Well, as you can see, the bond market is super pumped.

The Fed is going to start cutting in May and they're going to cut five times in total next year.

In order for that to actually happen, based on what the Fed has been saying, there are only two possibilities.

One is inflation somehow collapses much faster than it has actually been trending and hits 2% by the end of next year.

This is something that even the Fed's own models say would be two years ahead of schedule.

And I should point out that in the CPI report, the super core inflation that the Fed has been looking at came in at 4.5%.

So, basically, inflation still looks stuck.

But there is one alternative. That is recession.

Last week we talked about the economic data pointing towards a mild recession in 2024.

I can confirm that the newest data, which updates every week, came in still pointing to a recession. But now with 0.1–0.3% gross domestic product (GDP) contraction, which is the mildest in history.

For context, that would be approximately 2–3X milder than the recession of 2001, triggered by 9/11.

And of course, back then, unemployment barely budged.

So, the good news is Main Street should be fine. Not many job losses are expected.

But here's the problem for this immaculate disinflation rally that we've seen.

(Source: Bloomberg, FactSet)(Click here to expand image)

(Source: Bloomberg)(Click here to expand image)

This is a model that I built using data from Bloomberg and FactSet that simulates market bottoms in a recession any time in 2024.

So, you can see that even if there is no recession, the bond market is completely wrong, the data is completely wrong, and earnings come in 12% higher next year, somehow there's -2% fundamentally justified upside.

Of course, the market could do anything. It could fly off to 22–24X earnings.

So, it could still go up. But that would be an insane bubble even worse than today's.

Most likely though, analysts’ consensus is if we get a mild recession, which the data says is likely, stocks will fall by 20% for a 24% decline from the record highs set back in January of 2022.

If we get the average 13% earnings contraction that we've seen in recession since WWII, it would be a 27% decline in the S&P. And stocks would bottom at 31%, which is slightly lower than they did in October of 2022.

And Moody's Morgan Stanley has the most pessimistic outlook if we get a recession because inflation will be coming down quickly, which the market is right now.

That would crush margins 20% earnings contraction, which would be a 32% decline for a total of 36% decline from the record highs set in January of 2022.

But as you can see, 37% is the average bear market out of the 141 that Bank of America reports we've had since 1792 when the New York Stock Exchange began.

So it is completely average.

But this is why I'm telling you all of this. Because guess what? How did it feel in October?

It was doom, gloom, and boom, and doomsday prophets were out in force telling you about the next 50–70% lower. They said you had to be out of the market in cash or better yet, short everything.

Well, yes, that was ridiculous.

That was a completely normal correction and anticipated based on fundamentals. It was not something to be worried about.

And that's because you're not invested in the S&P. You're invested in the Fortress Portfolio with a 7% very safe yield.

We have a 5–8% growth range on this portfolio, 7.4% from FactSet, and 5.2% from Morningstar. And the portfolio is 21% historically undervalued while the market is 30% overvalued.

So we're looking at 21% discount and that means a 90% probability that over the next decade there's a 2.4% annual boost to returns just from valuation alone.

So, what kind of returns can you expect? Well, for context, for the next decade, analysts are expecting about 8.9% per year for the S&P, and about 130% total returns ten years from now.

For Fortress, it's between 14.4% and 17.4% per year, similar to what the S&P has done over the last decade stimulated by all that money printing.

The difference is now there is 284–397% total return. This is basically a 4X or 5X return for the next decade, which is essentially 2.5–3X better returns than the S&P 500.

All while you're earning a 7% yield that is growing quickly.

In fact, over the last five years, 12% income growth has meant 76% growth in dividends. Guess what inflation was: The worst inflation in 42 years–25%.

How is that for sleeping well at night with the world's best ultra-yield companies, the world beater blue chips with an average credit rating of BBB+, a 5% 30-year bankruptcy risk, and according to S&P, risk management in the top 33% of companies in the world?

Which, by the way, are trading at just 10X earnings. For context, right now private equity–those billionaire hedge funds and billionaire sweetheart deals–11.5X.

This means you're getting Fortress at a 15% discount to billionaires. Even with the market near record highs.

It's always and forever a market of stocks, not a stock market. That's what Fortress is all about.

And let me highlight one company for you: Manulife, to show you the power of Fortress and why you don't have to worry about next year, unlike your neighbors and friends.

(Source: FAST Graphs)(Click here to expand image)

This is Manulife Financial, one of the best insurance companies you've never heard of.

It is one of the three largest in Canada, It has an A credit rating, meaning a .66% chance of going to zero in the next 30 years.

We recommended it around this price here at the start of January, up about 18%.

 That's actually more impressive than it sounds because you might be thinking, “Well, isn't the market up 20%?”

Yes, Magnificent Seven is. But everything other than Magnificent Seven is pretty much flat and so is value and high yield.

So, Manulife is absolutely blowing it out this year, still yielding 4.3%.

Now take a look at this. So right now, it’s trading at 8.3X, but 7.8X forward earnings for next year.

That is pricing in–according to the Graham Dodd fair value formula–from the man who invented how to value companies that taught Warren Buffett everything he knows.

It has -1.5% long term growth, but it is growing at 7%. And I can confirm that long-term beyond 2025 will also be 7%.

Management, by the way, is guiding for 10% growth. Dividends and earnings are growing and there are very great returns so far.

And take a look. Over the next two years, there is 60% upside potential, 26% annually. That is better than Buffett's historical returns. That is, in fact twice the return that hedge funds are trying for while charging customers 5%.

Meanwhile, you're not getting charged 5%. You're getting paid 4.3%.

(Source: FAST Graphs)(Click here to expand image)

And meanwhile, let's take a look at the S&P 500. You can see overvalue for the last few years.

Most of the time, even if earnings come in rock solid, better than expected, and with no recession, it is still around 16% return potential. This is just 8% annually.

So, you're looking at more than triple the return potential of the S&P 500 with almost triple the much safer yield from an A-rated company trading at less than 8X earnings.

This is what I'm talking about: It's always and forever a market of stocks, not a stock market.

And even with the market basically back to record highs, there is always incredible blue-chip opportunities that you can find.

They can safely take care of your money, shower you with dividends, are growing rapidly, and are crushing inflation–the worst inflation in 42 years, which we beat by 3X.

That is the power of Fortress.

That is the power of trusting the world's best ultra-yield blue chips to help you reach your retirement dreams on an ocean of dividends.

Thank you so much for joining us.

As a reminder, our next video update will be on January 10. We will take a look at what the Fed just did on Wednesday, and what it means for the economy and the Fortress Portfolio.

Remember to please send us your questions and feedback so I can respond to them in these videos and our monthly issues.

And until January 10, this is Adam Galas wishing you and your family a glorious holiday season, a wonderful new year, and a safe, healthy, and relaxing time with family and friends.