Equity buyers are rushing for their share of cake

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Fear of missing out, aka “fomo”, is a powerful market emotion and there’s quite a rush at the moment, somewhat akin to the office scenes around the arrival of the weekly FT cake trolley

A way of gauging the growing risk appetite among equities is through the recent pick-up in the performance of smaller versus larger companies. US small-cap benchmarks, the Russell 2000 and S&P 600, remain about 8 per cent and 10 per cent respectively below their record peaks of 2018 and have lagged this year’s rebound for the S&P 500. If the prospect of a US recession is off the table, then small-caps should benefit and that has been the case of late, mirroring the rebound seen for economically sensitive equity sectors. 

One quibble with this view is that the latest US Small Business Optimism index only edged up in October to 102.4, a reading that loiters below levels recorded during 2017 and 2018. Capital expenditure plans among small businesses also continue trending lower (on a rolling 12-month moving average basis), hardly encouraging news and mirroring the trend for S&P 500 companies. But as Market Forces recently highlighted, positioning in equities has been overshadowing any red flags flying about earnings, capital expenditures, leverage and economic data.

This was duly illustrated by the latest monthly survey of global asset manager by Bank of America Merrill Lynch, which outlines how the year-end chase for performance has traction. This is illustrated by investor cash allocations dropping to a net overweight of 18 per cent for this month. That takes it below the long-term average of 21 per cent and is the lowest cash allocation since November 2015, when the figure was 16 per cent, says BofA.

In turn, investor allocation to global equities has risen sharply to a “net 21% overweight, the highest level in one year”. Meanwhile, when it comes to sector choices, there was no real surprises given the recent price action. BofA notes “a risk-on rotation into value stocks (vs growth), equities, banks and Europe, and out of cash, large-cap (vs small), utilities, staples and bonds”.

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Michael Hartnett, chief investment strategist at BofA, sums it all up:

“Investors are experiencing fomo — the fear of missing out — which has prompted a wave of optimism and a jump in exposure to equities and cyclicals.”

In contrast, sovereign bond investors seem to be heading for the exit. It’s probably worth keeping an eye on 10-year yield benchmarks for Japan and Germany from here as they are near key levels.

Japan’s 10-year yield appears set for a test of zero, having been in negative territory for much of 2019, while Germany’s benchmark is eyeing a push through the minus 0.20 per cent level that was broken in late-May. 

As the fiscal stimulus drum beats louder in Japan and Europe, expect yield curves to steepen, which will in turn bolster the share prices for banks. That is shown below via this chart from Capital Economics. The group notes:

“It highlights how shifts in investors’ sentiment about the economic outlook drives both bank equities and bond yields.”

It’s unclear how long this trend can run, but upward pressure on benchmark yields in Japan and Germany will drive sentiment farther afield, in the UK and US bond markets. 

For its part, Capital Economics believes eurozone “output growth will continue to slow and anticipate that the ECB will ease policy further next year” and “makes us doubt that the recent resurgence of bank equities will continue”.

The seeds of the next rotation are being sown as higher yields will eventually pressure risk appetite. But for now, there’s still cake on the table and in the spirit of Withnail and I, fine wines too.

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Quick Hits — What’s on the markets radar

President Donald Trump addressed the Economic Club of New York on Tuesday, and much of this rambling speech focused on how tax cuts and looser regulations have boosted the economy and equities. There was no mention of a federal budget deficit heading towards $1tn, let alone a recognition that the economy is slowing after its shortlived fiscal boost, with fourth-quarter GDP forecasts now running at 1 per cent or less.

For markets, the focus was on trade. After bemoaning his inheritance of “terrible trade deals”, Mr Trump eventually spoke at length about China and said “a significant phase one trade deal could happen with China, it could happen soon”.

But when questioned after his speech, Mr Trump said: “If we don’t make a deal, we’re going to substantially raise those tariffs.”

The mix of stick and carrot kept Wall Street off its earlier record highs before Mr Trump spoke, with the market closing near record territory, highlighting how market sentiment leans towards a deal, no matter the fine print, and let alone the damage already inflicted by the trade war on future business spending plans.

US equity buybacks have been a powerful tailwind for the S&P 500. Since 2010 the benchmark’s companies “have bought back the equivalent of 22 per cent of its market capitalisation”, according to Société Générale. But this pace is set to wilt a little. Here are SocGen analysts’ forecasts for S&P 500 buybacks: “$670bn for 2019 (minus 10% fall versus 2018) and $570bn for 2020 (minus 15% fall versus 2019)”.

The forecast of less buyback activity in 2020 is not much of a blow, as the bank says “corporate buying at twice the long-term average will act as a cushion for equity price action”, particularly given their “mild US recession scenario” for 2020. 

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High yield finds buyers when a particularly large central bank arrives on the scene. A renewed push towards the riskier waters of fixed income has been notable ahead of quantitative easing restarting under the European Central Bank this month. 

Fidelity is the latest group taking a positive view on European high yield, but with a focus on the UK market as the asset manager sees less risk of a hard Brexit. Fidelity notes: 

“UK companies have underperformed since the Brexit referendum, and with defaults remaining mostly idiosyncratic, seeing these companies return to the market more recently to raise capital has been positively welcomed by investors.”

Asian high yield also ticks the boxes for Fidelity. It believes:

“Continued easing from Asian central banks, better than expected trade war outlook and potential fiscal stimulus from China should continue to support the market.”

As for the US market, the impressive compression of risk premia for double B-rated paper leaves little room for improvement. The lower-end of US high yield, triple C credit, has been lagging and flashing a warning sign for the market. 

Fidelity adds:

“The US is further ahead in the credit cycle relative to Asia and Europe, and despite the resilient consumer and employment data, most economic data releases on the industrial and manufacturing front point to further deterioration. With valuations at the tighter end of the range and limited catalysts for spread tightening, we keep a neutral stance.”

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I’d love to hear from you. You can email me on michael.mackenzie@ft.com and follow me on Twitter at @michaellachlan.



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