Waiting for the stock market crash? Why it may never come and what it means for missed returns

"Far more money has been lost by investors preparing for corrections or trying to anticipate corrections than has been lost in corrections themselves." - Peter Lynch, mutual fund manager

Peter Lynch, the mutual fund manager who ran the Fidelity Magellan fund, where he achieved an average annual return of 29% from 1977 to 1990, knew a thing or two about market timing and the long-term power of staying invested and compounding returns.

The tone evident in the above quotation suggests it rarely pays to sit out on the sidelines waiting for the market to fall and prices to look ‘cheap’ again. It feels like we’re in this kind of situation where investors are waiting for a more attractive entry point because they don’t think the stock market can keep making record highs in the face 6% yields.

"It's also a mistake to sit on your cash and wait for the upcoming correction before you invest in stocks,” Lynch argued in his 1996 book, Learn to Earn. “In trying to time the market to sidestep the bears people often miss out on the chance to run with the bulls."

The question is whether there is much road left for the bulls to run on.

Why the market can keep going up

We’ve just had the first record intraday and closing highs for the S&P 500 since August even as bond yields have blown out to 24-year highs, which ought to be doing something negative to risk appetite. A US midterm cycle should also be keeping investors wary. 

Stocks have shrugged of the selloff in bond markets – or at least some of them have. And those that haven’t do not make up a large enough weighting in the indices.

This is an unusual story – higher yields ought by normal economic theory to weigh on high growth tech. But high yields are not pulling down on long duration growth stocks because the yields are a derivative of the AI buildout story that is driven by the companies’ collective spending and earnings, and which is driving stock prices higher. Moreover, megacap hyperscalers are growing earnings at a rate that doesn’t shout cash burn, even as capex this year has soared.

And it’s not to mask the fact that there has been a fair bit of damage to the US stock market as a result of tariffs, Iran war, inflation etc. Indeed, this is a rally built on very narrow breadth as rate sensitive sectors have fallen – about a third of SPX stocks are higher now than the September low for the index.

The rally is based on expectations for a powerful Q3 earnings impulse from the key protagonists as the AI buildout capex stretches out. FactSet data points to 29.5% earnings growth in Q3 year-on-year, which would be the third straight quarter with EPS growth +25%. At the same time yields have gone up, which has compressed valuations to around 19x from 23x at past peaks.

Despite making a fresh high this week the market hasn’t done much since May but earnings estimates have risen at least 20% higher, and yields are +100bps, so this is a market that is confident that this earnings cycle can withstand higher rates. Fundamentally this is because higher rates are a large extent high yields are a derivative of the AI buildout story that is driven by the companies and which is driving stock prices higher. Higher rates are the price to pay for this exceptional earnings growth.

To quote Bank of America’s latest Flow Show: “Rates don’t matter when you’re curing cancer.” It’s the investment in the AI buildout providing upfront impetus to earnings combined with expectations for productivity gains by adopters that is underpinning the strength.

It won’t take much of a pullback in yields – say an Iran truce, or divided government in Washington capping the Treasury issuance upside – to see stocks kick on into the year end. Despite all the headwinds the strength of this earnings cycle is too hard to ignore and too resilient to get kneecapped by higher rates. The thing to remember is that in this inflationary dynamic and with bonds losing their hedging qualities against a deteriorating fiscal backdrop your primary defence against erosion of value is to be invested in equities. They generate real tangible earnings and growth, usually at least in line with inflation.

And it’s too easy to forget the fiscal impulse for stocks. This goes hand in glove with the rates/equity story, because the US federal deficit runs at +6% this is stimulating nominal demand (good stocks) and increases supply that must be absorbed by debt markets, which means higher yields. As Noshad Shah at Citadel points out when assessing inflation outlook (stickier for longer), “fiscal support and strategic AI investment make parts of demand less rate-sensitive".

Hyperscalers have driven the broader market since the Sep low as there are increasing signs they are going to be able to deliver on the hype.

Microsoft provided a great illustration by expanding Copilot to include new models from both OpenAI and Anthropic. Because these are tightly integrated with an organisation's existing data and permissions, the underlying AI model can be swapped out seamlessly while the core customer relationship endures. The updated pricing now separates standard, subscription-based "everyday AI" from consumption-based, usage-heavy "agentic" work. Google has also noted it’s using Argon agents to improve data centre memory efficiency, which highlights how a model can support a larger business rather than carry the entire investment case itself, according to Shah. Hyperscaler economics extend beyond selling access to a single model, which makes them more attractive. "With an estimated one-third of hyperscaler capex debt-financed this year, the higher real cost of capital makes the timing and reliability of future cash generation more consequential," cautions Shah, before adding: "Existing cash flows, established distribution and multiple routes to monetisation therefore become more valuable competitive advantages…favouring integrated platforms in my view."

Reasons to be cautious

This is a much more demanding market due to the rise in yields. SPX earnings yield stands ~5.2%, while the 10yr Treasury trades above 5.25% now. So, the risk premium for owning stocks has evaporated as the discount rate has risen more than 100bps.

And Wall Street has never been this bullish on stocks despite the very obvious macro risks and concerns about concentration. According to FactSet, 60% of SPX stocks carry a Buy rating – the highest on record. Usually if everyone is expecting good news then there is a low bar for a disappointment. Earnings growth is predicted to continue its blockbuster streak with Wall Street analysts calling for +27.6% in Q4.

Incidentally, Analysts are most optimistic about Communication Services (XLC) (70% rated Buy), Technology (XLK) (70%), Materials (XLB) (64%), Energy (XLE) (64%), and Health Care (XLV) (61%) sectors, whilst they are most pessimistic about the Consumer Staples (XLP) (45%) sector.

As BofA notes, the bull case is “it’s the railroads this time”. AI capex stands at about 3.5-4% GDP vs. 5% railroads peak. The difference - the price of semis is soaring vs. deflation of freight rates which topped railroads. The worry is that big top in railroads was caused by credit/liquidity events, which speaks to fear from the rapid rise in yields creating distressed corporate debt contagion story. JPMorgan reports distressed US leveraged loans are at their highest level since the early months of the Covid pandemic, with tech companies, at 39% of the whole, accounting for the largest share.

And concentration risk is staggering – Nvidia, Apple and Microsoft make up 21% of the S&P 500. If the AI trade sneezes, it’s going to be full Covid-19 pandemic for the rest of the market.

Alongside concentration, the correlated worry is low breadth in the rally, with just 25% of S&P 500 constituents trading above their 50-day moving average, which is an unusually weak level for a market at a record high.

"Low breadth is a classic feature of bubbles building and typically doesn't stop until they pop," BofA analysts wrote in a note this week, where they warned of bubble risks in US tech stocks (QQQ).

Should you buy at all-time highs?

Should you buy when stocks or indices are at all-time highs? This might be considered buying something that is ‘expensive’. When a stock or an index is at an all-time high, we often refer to ‘psychological barriers to entry’ - people get scared because it’s never been this high before and looks pricey as a result. Investors instinctively want to wait until it’s trading a little or a lot cheaper. 

But this way of thinking is closely linked to trying to time the market – something that even seasoned professionals agree is almost impossible to get right.

Sometimes you need to reverse your thinking and look at the percentages. Momentum strategies are not based on nothing.

In 2024, RBC Global Asset Management looked at the 1,250 all-time highs for the S&P 500 since 1950 and found something interesting – buying the top worked. Indiscriminate buying of the index delivered average 5yr returns of 11.3%, compared to 10.3% for ‘buying the top’. In other words, your returns would be close to the average return – and they found this was similar across the 1yr and 3yr horizons too.

Scottish Widows also did some research on ATHs for the S&P 500 going back to 1926. Notably, the investment manager found 12-month returns following an all-time high were better than at other times: 10.3% ahead of inflation compared with 8.6% when not after an ATH.

Research by Schroders found that a £1,000 investment in the FTSE 250 from 1989 to 2019 yielded £26,831 if fully invested, but dropped to £7,543 if you missed just the 30 best days

Investing when a stock has hit an ATH is linked closely to momentum strategies. A famous 1993 study published in the Journal of Finance showed trading strategies that buy past winners and sell past losers realised “significant abnormal returns” over the 1965 to 1989 period. For example, the strategy which selects stocks based on their past 6-month returns and holds them for 6 months realised a compounded excess return of 12.01% per year on average.

It’s normal to be nervous when markets hit ATHs – but the stats suggest staying invested, and perhaps adding to winning positions, can work.

Key Takeaways