Stocks are moving into the 'euphoria' stage of the cycle, and there are growing signs of 'exhaustion' in the market, Jefferies warns

• US stocks closed at new records on Tuesday, but US bank Jefferies thinks stocks have reached the sort of "euphoria" that tends to precede a correction.
• Sean Darby, global equity strategist at Jefferies said in a note: "Some of our indicators are beginning to move into the 'euphoria' stage, and we caution that managing drawdown risk is coming to the fore."
• The bank said a close watch should be kept on the US 30-year yield and "any sign that the US money supply is rolling over."
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Just as the S&P 500 and Nasdaq hit their highest levels ever on Wednesday, one analyst says the market is starting to show signs of the sort of "euphoria" that tends to come before a major correction.

In a note Tuesday, Sean Darby, global equity strategist at Jefferies said: "US earnings expectations have certainly 'V-shaped' and this has been accompanied by an enormous reversal in risk appetite in almost a miniscule amount of financial time."

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"Some of our indicators are beginning to move into the 'euphoria' stage, and we caution that managing drawdown risk is coming to the fore," he added.

The S&P 500 closed at yet another high on Tuesday, ending the day at 3443 points. The tech-heavy Nasdaq also hit its highest close ever at 11,466. The S&P 500 has recovered 53% since touching coronavirus lows in March.

Stimulus packages worth trillions, coupled with rock bottom interest rates, have helped investors flock to equity markets in recent months, and bolster pandemic stricken companies, which in turn has pushed stocks higher.

The investment bank said while the coronavirus pandemic proved to be a challenge for corporations, the "recovery in US earnings revisions has been the fastest on our records."

But Darby said there are signs the stock market rally is running out of steam.

"In the last 10 or so trading days," Darby said, "the US equity markets have begun to display some signs of exhaustion despite the new highs being made."

"We highlight that this rally has been well above the average of the previous S&P 500 recoveries from market lows."

The bank points out the following worrying signals:

• Increasing divergence of the top 20 S&P 500 stocks from their 200-day moving average.
• The S&P 500 Index is making new highs, but the equal-weighted index — which gives equal weighting to all 500 companies in the index — is flat-lining.
• Global risk appetite and S&P 500 sentiment indicators are pretty close to "extreme" levels.

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Jefferies concludes: "The bottom line is that as investors 'buy' into the 'earnings growth', risk appetite is moving into the euphoria stage."

"The obvious catalysts for a correction are not present but the technical 'stretch' of some of our indicators are a warning sign. A close watch should be kept on the US 30-year yield and any sign that that US money supply is rolling over," the bank added.