In one rather dark internet meme, a bulgy-eyed cartoon dog wearing a small hat sits sipping from a mug at a table, surrounded by encroaching flames. “This is fine,” it says to itself. Financial markets have a similar ring to them now — investors know something is wrong, but they are carrying on regardless.
The monthly survey of fund managers compiled by Bank of America is always a useful way to test the mood. April’s update reflects the canine’s situation rather neatly.
Some 71 per cent of investors are expecting a weaker economy over the next 12 months, the survey showed. It’s the most pessimistic reading ever on data going back to 1995 — not even March 2020 and the financial crisis of 2008 match it. A clear majority of investors — 64 per cent — expect the benchmark S&P 500 index of US stocks to drop below 4,000, a 10 per cent fall from current levels, before it cracks above 5,000.
Worries that pesky central bankers will spoil the market mood with an overly aggressive withdrawal of stimulus are also acute. Perceptions of monetary risk to financial market stability are at a record high. Fund managers in the survey now expect to see an average of 7.4 rate rises from the US Federal Reserve this year, up from 4.4 in March. Some expect as many as 12 rate rises in this cycle, or even more.
In addition, anyone who tells you they know how the process of the Fed chopping back its balance sheet will work out for markets is guessing at best, fibbing at worst.
It is hard to put an optimistic gloss on all this. And yet, as BofA points out, “the disconnect between global growth and equity allocation remains staggering”. Over the month, somehow, “investors got slightly more bullish on equities”, with the proportion of fund managers saying they are overweight stocks edging higher.
Fabiana Fedeli, chief investment officer for equities at M&G, is among those who feel something is wrong with this picture. “The market seems confused,” she says.
Almost from week to week, investors are flipping from favouring stocks in sectors like banking and energy — so-called value stocks that are typical beneficiaries of an environment of higher inflation — to whizz-bang growth stocks in technology that benefit from decent growth and the comfort of low interest rates.
This back and forth (or, as she more elegantly puts it, “pas de deux”) between growth and value “makes me feel less positive on equities, if not outright cautious”, Fedeli says. She is neutral to short equities, concerned, among other things, that consumer demand is falling back under the pressure of rising prices.
“Last year was really bullish for equities. Now I’m not seeing the same slam-dunk,” she says, particularly since the invasion of Ukraine sent commodity prices soaring from already elevated levels. “There’s a lot that can go wrong. It does feel like markets are extremely complacent. We’re in a growth declining environment. It’s looking most likely we have growth that’s going to be revised down — [economic] growth and earnings growth — and valuations do not reflect that.”
This week’s inflation data from the US added to the sense that investors know the game is up. The headline inflation number struck yet another four-decade high, at 8.5 per cent. But core inflation, stripping out volatile food and energy, advanced by just 0.3 per cent on the month. Yes, that still leaves the annual rate at a startling 6.5 per cent, but it is the tamest monthly gain since September and offers a flicker of hope that the most blistering phase of the inflation cycle may be behind us, perhaps allowing the Fed to go slower with its rate rises. Used car prices, which have imposed so much upward pressure on inflation over the past year or so, finally pulled back.
It is reasonable to think that might pull down long-term US debt yields. Not this time, however. “CPI comes in OK and the 30-year yield is rising?” notes Fedeli. “That tells you the market does not know where we are going, but it does know that the path we have been on is not the right one.”
So, what next? Dumping stocks in favour of bonds brings a sense of jumping out of the frying pan and into the fire, and it certainly did not work out in the first quarter of this year. Fedeli at M&G says it “sounds boring”, but the answer is to stay diversified and focus on fundamentals.
Another option is to load up with tail risk hedges that pay out handsomely in the event of a crash. Jordan Sinclair, a director at Capstone Investment Advisors in New York, said that is what his clients are increasingly opting for now. “People are pretty jumpy,” he says. “Caution is turning into outright bearishness. You can hold large cash balances, you can sell equities or you can tail hedge.”
That is also the recommendation from Goldman Sachs. “We remain overweight equities in our asset allocation but would focus on managing risks with tail risk hedges,” wrote Christian Mueller-Glissmann and colleagues at the bank. “Investors need to balance the ‘time in the market’ with ‘timing the market’ as divesting too early can mean giving up positive equity returns.”
As the cartoon dog says: this is fine.
katie.martin@ft.com
