US stocks are motoring, but investors are not ready to celebrate just yet.
This week’s gains in the blue-chip S&P 500 index mean it now stands more than 20 per cent above its October 2022 low, nudging the Wall Street benchmark into the widely-used definition of a bull market.
But persistent concerns about the true health of the US economy and anxiety over the tiny number of stocks driving gains are still sapping enthusiasm among fund managers.
“While many investors believe that passing this milestone puts markets in bull territory, it remains possible that we are seeing a bear market rally — a period of strong gains that occurs in the middle of a bear market,” said Solita Marcelli, chief investment officer for the Americas at UBS Global Wealth Management.
“Until markets reach a new all-time high, it’s impossible to know whether the bear market trough — the ultimate low of the market cycle — is behind us. We recommend investors continue to exercise caution,” she said.
An all-time high is still 12 per cent away, but stocks’ upward momentum this year is hard to ignore. The rally is at odds with a widespread downbeat tone among money managers, most of whom came into this year expecting a recession that has yet to arrive. A string of upbeat data, particularly on employment levels, has complicated that view and left many investors struggling for direction.
“I think there’s a much higher probability that surprises continue to be positive rather than negative,” said Savita Subramanian, head of US equity and quantitative strategy at Bank of America. “But I can’t find an unequivocally bullish investor.”
A key preoccupation is persistent US inflation, which raises the prospect that the Federal Reserve has not yet finished with its aggressive interest rate increases. That policy could potentially worsen any downturn and pull down bond prices and the value of tech stocks in particular — a typical pattern that played out last year.
Central banks’ battle against inflation “does not support the bulls’ thesis”, said Lewis Grant, portfolio manager for global equities at Federated Hermes.
The narrow nature of the rally has exacerbated the hesitation, with just seven big stocks responsible for the S&P 500’s 12 per cent gain this year.
“For all the brash headlines, away from a couple sectors and a select group of stocks, markets haven’t done much”, said Peter Tchir, head of macro strategy at Academy Securities. “All the talk of a bull market seems to create the hype that investors are missing something, but that really isn’t what has been happening.”
Anyone tracking the equal-weighted version of the S&P 500 — a strategy that dulls the impact of a few heavyhitters — is up less than 3 per cent this year.
“Investors like a lot of little confirmations of their biases and here they’ve got 400-something stocks that seem to be telling them something less positive,” said Jonathan Golub, chief US market strategist at Credit Suisse. “But here’s the bottom line: we’re only interested in weighted average returns, not the average return. And these big companies count a lot more.”
The seven leaders are all in tech: Nvidia, Tesla, Google, Microsoft, Apple, Amazon and Facebook parent Meta. Exposure to the potential of generative artificial intelligence has boosted Nvidia, Microsoft and Google in particular.
“While these leading tech companies have become more expensive, they’ve also seen their earnings outlook improve which is clearly part of this story,” added Golub.
Morgan Stanley’s equity strategy team this week renewed its call for a tactical bear market in a longer-term bull run, based on a cut to its earnings forecasts.
“If this new inflationary regime mirrors the post-WWII period, it will be volatile with significant cyclical ups and downs that should be traded if one wants to fully capture excess returns,” the team wrote in a report to clients. “In short, the boom/bust period that began in 2020 is currently in the bust part of the earnings cycle — a dynamic that’s not yet priced, in our view.”
“Durable bull markets tend to begin when earnings estimates bottom”, said Sean O’Malley, head of strategy at $2.3bn hedge fund Cadian Capital. “Broad market earnings estimates are falling and don’t seem to have bottomed”.
The mood has improved a little. Goldman Sachs’ market sentiment indicator has turned positive for the first time since the autumn, while a weekly survey by the US National Association of Active Investment Managers showed the biggest one-week jump in its members’ equity positions in two years and their highest holdings since November 2021.
Next week’s Fed meeting could spur fresh gains — or confirm investor jitters. While the central bank is expected to hold interest rates steady on Wednesday, futures markets suggest a further quarter-point rate rise in July has been priced in following a series of bumper economic reports. Investors have yet to decide whether stronger data boosts the soft-landing scenario, or sparks fresh worries that an over-hawkish Fed will push the economy into recession.
Additional reporting by Laurence Fletcher
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