Why the explosive stock market rally is suddenly crumbling

A red-hot stock market may be starting to get crushed under the weight of its own inflated valuation.

Seemingly out of the blue, the Dow Jones Industrial Average tanked nearly 800 points on Thursday by early afternoon trading. More alarmingly, the Nasdaq Composite — which has led the rally off the late February lows — plunged about 4%.

Some of the sector’s strongest-performers in recent months were walloped Thursday: Amazon (-5%), Apple (-7%), Microsoft (-5%), Tesla (-7%), Zoom (-11%), Square (-7%) to name a few. Indeed the selloff in these tech giants has served as a red flag on the rally’s near-term sustainability for the bulls, which have also watched an under-the-radar rotation into more defensive names this week such as Procter & Gamble and Coca-Cola.

Talk to those on the Street and a selloff right now makes sense, and is long overdue.

For starters, valuations on big tech names like Tesla have gotten completely out of whack with reasonable expectations on forward earnings. A signal on that front was sent on Tesla Wednesday, as one of its largest shareholders Baillie Gifford trimmed its stake after a meteoric run-up in the stock. Meantime, billionaire investor Mario Gabelli hinted in an interview with Yahoo Finance editor-in-chief Andy Serwer he may soon trim some of his position in Apple (another 2020 high-flyer).

And then there is the raw economic data that hasn’t improved much in recent weeks as the COVID-19 pandemic rages on. Or at least hasn’t turned around enough to warrant the S&P 500 trading at a lofty forward price-to-earnings ratio of 22 times.

“It could be the start [of a correction],” Belpointe Asset Management chief strategist David Nelson told Yahoo Finance’s The First Trade. “I don’t think the stock market — and particularly the S&P 500 and Nasdaq — really represents what is going on in the economy.”

Exterior of New York Stock Exchange Building with classical architecture of Greece columns and US flags as seen during the day, NYSE Financial organization at Wall Street a symbol for the global and American Economy as one of the most powerful financial institute at lower Manhattan New York City, United States of America. February 2020, NY, USA (Photo by Nicolas Economou/NurPhoto via Getty Images)

To top it all off, there are the seasonal September forces — and what will be a heated presidential election — the bulls seem to have forgotten about.

September tends to be a weak month for stocks historically. In fact, according to LPL Financial, September has been the worst-performing month for markets, on average, since 1950. The S&P 500 has dropped about 1% on average that month since 1950, LPL Financial data shows. The only other month to record a drop on average (and a minuscule one at that) going back to 1950 is August.

But this time around, September being lackluster for markets could be further solidified because of election-related uncertainty. LPL Financial data reveals that the S&P 500 has shed 0.2% on average in an election year. 

“When we look at Tesla, it’s trading at a market cap of $455 billion which is 10 times what General Motors is trading at. And so we have to wonder can fundamental analysis sustains some of these valuations? When we look at Zoom, it’s trading at more than IBM and at a P/E ratio of over 500 times versus IBM at 15 times. What I think is happening is investors are starting to scrutinize the valuations a bit more,” says Greg Branch, an adviser at 1847 Financial.

Brian Sozzi is an editor-at-large and co-anchor of The First Trade at Yahoo Finance. Follow Sozzi on Twitter @BrianSozzi and on LinkedIn.

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