Are equity markets a bear in bull’s clothing?
Strong equity market returns in 2019 have masked investor nerves and active asset mangers' reticence to buy stocks. The latest utterances of US Federal Reserve chair Jay Powell suggest they are right not to be taken in by record-breaking stock indices and that this bull market may be short lived.
Few equity investors speaking to GlobalCapital regularly express the levels of optimism that you would expect given market returns so far this year.
Last week the S&P 500 closed above 3,000 — a record high and 28% above its most recent low recorded before Christmas. Many market participants consider a 20% increase from a 12-month low to be a sign of a bull market.
In stark contrast, active equity investors have pulled money from the market. As of last week, there had been almost $150bn of outflows from global equities year-to-date, according to fund data tracked by Bank of America Merrill Lynch and EPFR Global.
Passive flows have been positive with ETFs contributing $60.5bn of global inflows but long-only funds have pulled $210.4bn from the market.
One strategist said this week that algorithmic trading and corporates have been the main drivers of equity performance so far this year.
Active investors' risk sentiment has been cowed by lower retail flows with individual investors still smarting from the large losses they took at the end of last year, and increasing concerns about the effects of geopolitical risks such as the US-China trade war.
The lack of active participation in equities has spread to primary equity markets, with IPO investors still cautious about committing to new listings.
Any buyers who feel this sense of concern will likely heed the words of Powell when he told US Congress last Thursday that “it appears that uncertainties around trade tensions and concerns about the strength of the global economy continue to weigh on the US economic outlook.”
Should the Fed cut rates this year and say that it is doing so because it thinks the US economy is slowing, then any upside for equity markets is likely to be limited. A slower economy means lower corporate earnings which would stem some of the benefits for investors who have positioned themselves for a dovish Fed.
Historically, the S&P 500 has tended to decline 12 months after a rate cut, if the cut had been made to remedy a slowing economy.
If the US economy does slow, perhaps due to global trade tensions, it will justify the defensive positioning of many active investors.
Investors who have stayed away may have missed out on some of the juicy returns this year but who wants to catch the knife when it falls? Bankers pitching new listings must keep that in mind as the world's most important central bank seems to have come round to the more bearish view.