The stock market is showing signs of foam and two catalysts could cause a significant sell-off, says Ken Griffin

• US stocks are showing signs of real foam in their valuations, according to Citadel’s Ken Griffin.
• He said stocks are loosening from their fundamentals and the multiples are very high.
• These are the two catalysts that Griffin expects to derail the historic stock market rally.

Since the market bottomed out on March 23, 2020 amid the COVID-19 pandemic, stocks have done nothing but rise.

That has conditioned investors to buy any dip along the way, as they’ve rightfully been rewarded for taking more and more risk, Citadel’s Ken Griffin told Andrew Ross Sorkin at Wednesday’s DealBook conference.

And while investors’ buy-the-dip behavior has been a major boost to markets over the past year, Griffin says it could also end badly if stocks begin to detach from their underlying fundamentals.

“I think [the stock market] is really frothy,” he said, pointing to the volatile moves in high-flying stocks like Tesla.

“Significant stock price movements on relatively minor events” represent a sign of market foam, he added, likely referring to Tesla’s nearly $200 billion market cap after it struck a deal with Hertz worth just $4 billion.

Griffin outlined two key catalysts that could bring down the current bull market rally as stock multiples reach extreme levels.

“As the multiples get incredibly high, any kind of policy flaw or a company going through a bad period will result in a pretty dramatic stock price reversal,” he explained.

A policy flaw could come from the Federal Reserve, as strategists have warned that an early Fed tightening could lead to a fall in stocks. The central bank recently initiated plans to phase out its monthly bond-buying program, though most don’t expect it to raise interest rates until late 2022 or early 2023.

The Fed could also make a policy mistake by not tightening financial conditions and instead allow inflation to rise too high, with higher wages leading to structural inflation, Griffin said.

“[The Fed is] will have to make some pretty tough decisions about both the pace of winding down and the rate at which they raise interest rates in 2022,” he said.

Meanwhile, a slowdown in growth for mega-cap tech companies facing supply chain constraints or a lack of demand could shock investors and cause the stock market to fall, he added.