Stock market peak? ‘Easy money’ has been made but room for more gains, strategists say

Those concerns aren’t necessarily misplaced. “A lot of easy money has been made,” Malik said, but there is still scope for gains. Investors, however, will need to be more selective, focusing on companies and sectors more likely to top rising earnings expectations, she said.

Related: Stock market will struggle as bullish earnings expectations get out of hand: economist

The past week was hardly a disaster. The S&P 500 index SPX, -0.72% and Nasdaq Composite COMP, -0.85% both traded in record territory, but no breakouts were to be had. The Dow Jones Industrial Average DJIA, -0.54% ended the week down 0.5%, while the S&P 500 was virtually flat and the Nasdaq Composite fell 0.4%.

Monthly performance was nothing to sneeze at, with the S&P 500 rising 5.2% in April for its strongest month since Novembe. The Nasdaq’s 5.4% rise for the month was the strongest since December. The Dow rose 2.7% in April.

The week ended with data that showed a 21.1% rise in personal income in March, fueled by fiscal stimulus checks, and accompanied by a 4.2% jump in personal spending. It followed an estimate of gross domestic product data that showed the U.S. economy grew at a rapid 6.4% annual pace in the first quarter.

Read: Americans have a few trillion in extra savings to keep the economy going strong

And the strong economic readings are almost certain to continue in the week ahead, with the Institute for Supply Management set to release its manufacturing index for April on Monday and its April services sector gauge on Wednesday. Friday will bring the May jobs report, with some economists seeing the potential for nonfarm payrolls to rise by more than 1 million.

Questions about whether this is “as good as it gets” are understandable, given that booming data, particularly for purchasing managers indexes, often herald monetary policy tightening by the Federal Reserve that lead to a slowdown, said Quincy Krosby, chief market strategist at Prudential Financial, which has $1.721 trillion in assets under management.

But the Fed remains committed to allowing the economy to run hot, she noted.

Chairman Jerome Powell on Wednesday reiterated that it remains too early to even consider talking about pulling back on the central bank’s extraordinary monetary stimulus measures, arguing that signs of inflationary pressures remain “transitory.” And while some employers are complaining about labor shortages, the jobs market is still far from tight as the economy continues to recover from the pandemic, he said.

See: What’s next for Fed? A signal of ‘taper’ from Powell in late August at Jackson Hole

A Fed on hold bodes well for interest rate-sensitive stocks, particularly those tied to the consumer as the economy continues to reopen, Krosby told MarketWatch.

Travel and leisure stocks and some other consumer-oriented parts of the market “can still do extremely well,” she said. Add in President Joe Biden’s infrastructure spending proposals and there’s room for industrials as well as clean energy names, which have already done well, to benefit, Krosby said.

Malik is also upbeat on consumer-oriented companies, while industrials are set to benefit from continued economic growth and infrastructure spending. Financial firms should be poised to beat earnings expectations and should benefit from higher interest rates as inflation pressures push yields higher, she said.

Malik is also bullish on small-cap stocks. While the small-cap Russell 2000 RUT, -1.26% has outperformed the large-cap Russell 1000 RUT, -1.26% by more than 2 percentage points in the year to date, the small-cap index still looks undervalued, she said.

The 12-month forward price-to-earnings ratio for the Russell 2000 stood at an 18-year low versus the Russell 1000 at the end of March, Malik noted, and record inflows into equity funds over the past five months have gone almost solely to large-cap stocks while small-caps have seen marginal outflows.

Over the past month, small-caps have underperformed thanks to the rising number of COVID-19 cases around the globe, especially in Asia, and questions over whether the economic reopening has been priced in, she said. But small-caps should be able to benefit from rising commodity prices and inflation.

And then there’s politics. Stocks wobbled on April 22 after a news report highlighted Biden’s plan to propose a near-doubling of the capital-gains tax rate on investors making more than $1 million a year to 39.4%. But those losses were soon erased.

Investors overall seem unfazed by Biden’s call for personal income tax hikes on the wealthy and a rise in the corporate tax rate. Stock market performance over Biden’s first 100 days in office, which ran through Thursday, was among the best of any presidency.

In part, that’s because market participants expect pushback by some Senate Democrats, where the party has a razor-thin majority, to water down the proposals, analysts said. Also, the economy-boosting spending proposals are also expected to provide a lift to the economy and earnings, particularly for companies that stand to benefit from infrastructure spending and other programs.

But tax hikes and the prospect of increased regulatory scrutiny will add to a more selective environment more favorable to stock- and sector-picking, analysts said.

Those factors and the fading of other “systemic tailwinds,” such as falling interest rates will contribute to a transition away from a backdrop that saw “everything being favorable from a Wall Street perspective” to an environment with more differentiation, said Brad McMillan, chief investment officer at Commonwealth Financial Network, in an interview.

The market, meanwhile, could be due for a pullback, analysts said.

Given the scope of gains, it wouldn’t be a shock to see investors get spooked by any near-term, negative surprises on the tax front or talk around when the Fed will begin to taper its bond purchases, Krosby said, but added that at this point “all pullbacks are healthy.”