By Mike Dolan
LONDON (Reuters) – As often happens in the markets, it might be time to get a little anxious when there is nothing but blue skies all around.
Pulling out just about every macroeconomic metric you can think of these days, there appears to be a positive turn, at least for stock markets at record highs that posted gains of more than 10% for a first quarter that was marked early on by much angst and trepidation on the part of investors.
US stocks are expensive but not extreme, the argument goes, and earnings forecasts for next year are rising rapidly to almost 14%. US economic growth is slowing slightly, but this year’s recession now seems far-fetched.
Interest rates, still high, are expected to start falling over the summer as rather sticky inflation eases again. And indicators of implied volatility in stock, bond and currency markets are unusually low.
The picture outside the US may be more patchy, but stocks in Europe or Japan are also cheaper and the nadir of economic growth in both areas may already be over. European rates may even start to fall before their US equivalents.
Furthermore, the big problem of the last 18 months for many – stock index gains that had been overly concentrated in a handful of Big Tech and AI-infused winners – is starting to unravel and gains are clearly widening as recession fears fade and they increase. cuts close.
Since the bottom of the bond crisis last October, the S&P500 benchmark has gained 25% in just 5 months.
But the equally weighted version of the index – which corrects for the outsized performance of major large-cap companies – jumped 23% in that period, small caps rebounded 26% and Japanese and euro zone blue chips rose 28% and 25% respectively. dollar terms.
Reflected in these stellar gains, the concerns of the early part of the new year appear to have come to a complete halt.
Bank of America’s most recent global fund manager survey showed equity allocations at two-year highs and the highest “risk appetite” indicators since November 2021. Prior to November there had been a net underweight position in shares for 18 consecutive months: the longest and darkest period. record since the 2008/09 crash.
Have all the doubters turned to the believers?
And have the bears finally capitulated after 18 months of underperformance?
If so, that unnerves some asset managers who were happy to swim against the pessimism at the start of the year – even those who mostly agree with the bullish thesis.
Yves Bonzon, chief investment officer at Swiss asset manager Julius Baer, said the firm is starting to wobble on its still overweight equity position, fearing a combination of consensus, a seasonal lull in stock demand over the summer and the impending uncertainty of the US elections.
“For almost four weeks we were tempted to marginally reduce equity risk and hedge,” he said. “So far we have refrained from doing so, but if I were forced to increase or reduce the shares I would be tempted to reduce them slightly.”
“There will be a consolidation phase between now and November in the markets: a 10-15% correction could happen at any time and, I would say, that would be healthy,” he added.
“Shocks are by definition impossible to predict (but) markets are probably more vulnerable to an external shock than we have been at any time since COVID hit in 2020.”
BACK TO THE FUTURE
Interestingly, according to Reuters global stock polls, a 10% correction in the S&P500 from current levels would bring it more or less back to where consensus forecasts for the end of 2024 were in November.
The median forecast for the end of 2024 was revised sharply upward in last month’s polls to 5,100 and to 5,300 for the end of 2025.
But for the most part we are already there.
What to do: continue riding the wave or bet a little to hedge?
With 30-day implied stock volatility captured by Wall Street just 3 points off record lows, there may be a temptation to hedge stock portfolios with options.
But many asset managers have instead used short-term cash interest rates above 5% as an effective hedge.
And many are now overweight in both stocks and cash.
According to data from the Investment Company Institute, U.S. money market fund assets topped $6 trillion this month for the first time ever: nearly $1 trillion more than a year ago and nearly double the pre-pandemic levels.
And this is one of the main reasons why investors are reluctant to turn away from stocks unless there is some dramatic turn in the favorable macroeconomic picture.
The assumption is that the liquidity is there until the Fed finally starts cutting short-term interest rates – and futures have already predicted this for June. Then it starts flowing into bonds or stocks.
If the Fed hesitates to implement monetary easing in the second quarter, the summer could be turbulent.
Election uncertainty in the US therefore looms large to complicate any recovery, although the bullish economic backdrop is believed to hold true through 2025 regardless of the outcome.
Chris Iggo of AXA Investment Managers points out that the average return during US presidential election years was around 11%. And that’s what’s being done as early as 2024.
But “if we are now in a favorable growth cycle, then financial market returns could be more similar to their long-term averages,” he wrote. “That means a little higher for bonds than in recent years and a little lower for stocks than last year. But overall good.”
Maybe bullish and bearish at the same time.
The opinions expressed here are those of the author, a Reuters columnist.