NEW YORK — Several indicators that pointed to a rise for U.S. stocks this year have shifted to a more neutral outlook, potentially leaving equities vulnerable to turbulence from a recent surge in bond yields and worries about China’s economy, investors said. investors.
Some investors watch so-called contrarian indicators to gauge market sentiment, with extreme pessimism seen as a good sign to buy and vice versa. At the start of the year, measures such as equity positioning and cash allocations showed an extreme decline, reflecting investors’ gloomy outlook after a sharp sell-off in 2022 and expectations of a recession in the second half of this year. year.
But signs of a resilient economy and slowing inflation sidelined investors and boosted risk appetite in the months that followed, fueling a nearly 14% rise in the S&P 500. This year. The result, some say, is that there is now less cash on the sidelines to generate further gains and fewer skeptical investors to convince.
While bearish positioning was a “strong tailwind” for risk assets in the first half of 2023, it is “not so” in the second half, BofA Global Research strategists wrote in a report earlier this week. .
The bank’s survey of fund managers showed cash allocations fell to 4.8% in August, the lowest level in 21 months. This moved its ‘cash rule’ indicator – which sits at ‘buy’ when allocations are above 5%, to ‘neutral’. The survey also showed that fund managers were the least bearish since February 2022.
The downtrend for retail investors, meanwhile, is at half the levels seen in September 2022, according to the AAII sentiment survey.
“There was a lot of pessimism in the market earlier this year and this shift from pessimism to optimism fueled a rally,” said Willie Delwiche, strategist at Hi Mount Research. “We’ve seen it go quickly from overly pessimistic to overly optimistic, and now we’re starting to see that reverse.”
Investors are eagerly awaiting the Federal Reserve’s annual symposium in Jackson Hole, Wyoming, late next week to better understand how long the central bank intends to keep rates around current levels.
Optimism tested
The wave of optimism that helped fuel stocks is being tested this month, but it remains to be seen whether investors will see the declines as an opportunity to buy low or a signal to ease stocks. .
The S&P 500 is down more than 5% from its late-July intraday high, while yields on the benchmark 10-year U.S. Treasury on Thursday hit their highest level since October. U.S. real yields, which show what investors can expect to earn on Treasuries after adjusting for inflation, are near their highest since 2009.
Higher yields on Treasuries, which are considered virtually risk-free since they are backed by the US government, can make stocks less attractive to investors, especially as stock valuations are high relative to historical standards.
Meanwhile, concern over China’s deepening real estate crisis and its impact on the country’s weakening economy grew after beleaguered developer China Evergrande Group filed an application for relief this week. bankrupt in the United States.
“The market is particularly vulnerable right now” due to soaring bond yields and concerns about contagion in China’s real estate sector, said Quincy Krosby, chief global strategist at LPL Financial.
She expects stocks to remain volatile until companies start reporting third-quarter results in October. If the market stabilizes, investors will likely reallocate more cash to stocks later in the year, she said.
Of course, while optimism has increased, it is still far from extreme and cash levels are far from historic lows. Optimistic investors were encouraged by signs that the US economy is likely to avoid recession this year, even though inflation has cooled and the Fed is unlikely to raise interest rates further.
Steve Chiavarone, senior portfolio manager at Federated Hermes, recently increased allocations to sectors such as energy and materials in anticipation of greater economic growth.
“The market, if any, might not be bullish enough in the short to medium term,” Chiavarone said. His firm’s research found that historically, the S&P 500 has gained an average of 14% during pauses in Fed tightening.
“The time to go bearish is not today,” he said.
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