Stock market investors grow wary as equities hit new highs
CONCERNS OVER EQUITY VALUATIONS HAVE PROMPTED MANY TO TAKE PROFITS
Investors are girding their portfolios for potential stock market volatility, even as equities hover near fresh highs after logging seven straight months of gains.
Utilities are the S&P 500’s best-performing sector so far this quarter with a 10.2 per cent gain. They have been followed by other popular destinations for nervous investors, including real estate and health care.
In derivatives markets, the gap in price between the front month Cboe Volatility Index futures contract and the VIX index itself is higher than it has been about 85 per cent of the time over the last five years. This suggests some investors expect the calm in stocks to give way to more pronounced price swings in the coming weeks and months.
Meanwhile, the Japanese yen and Swiss franc — viewed as havens during uncertain times — have outperformed most G10 currencies this quarter.
“It’s been a year of positive market returns, but it’s a bull market which has pretty defensive undertones,” said Saira Malik, head of global equities at money manager Nuveen Investments.
Few alternatives
The demand for downside protection illustrates a conundrum that has bedevilled investors at various times during the market’s post-pandemic surge.
Ultra-low yields on fixed income have left few alternatives to equities, and betting against stocks has been a disastrous strategy in the last year-anda-half.
Stocks demonstrated their resilience on Friday, when the S&P appeared to shrug off a big miss on August US employment data, as some market participants bet a weaker economy could undercut the case for the Federal Reserve to unwind its market-supportive easy money policies in coming months. The benchmark index is up 20.4 per cent this year.
At the same time, many have grown antsy in a market that has gone 292 calendar days without a decline of 5 per cent or more, nearly three times the average since World War II, according to data from CFRA’s Sam Stovall. Rising valuations, ebbing economic growth and signs of speculative excess have only added to their concerns.
“It’s been a wonderful ride for US equities … but moving forward we think it is going to be a little bit of a different picture,” said David Grecsek, managing director in investment strategy and research and partner at Aspiriant, which manages about $14.5 billion.
Concerns over equity valuations have prompted Grecsek to take profits in some of his equity positions and shift some money into non-US stocks, including emerging markets.
The S&P 500’s price-toearnings ratio on a forward 12-month basis stands at 21.3, a 35 per cent premium to its 20-year average, according to Refinitiv Datastream.
Investors next week will be keeping an eye on quarterly results from video game retailer GameStop Corp, whose wild ride this year put a spotlight on retail investors’ mania for socalled meme stocks that some say is one sign of irrational exuberance in markets.
Inflation outlook
On the macro front, next week’s US August producer price index data could provide some clues on how inflation is shaping up after July showed the largest annual increase in over a decade.
With the Delta variant of the coronavirus continuing hindering growth, “a lot of investors are seeing maybe some headwinds and positioning more defensively,” said Ross Mayfield, investment strategist at Baird in Louisville, Kentucky.
Analysts at Morgan Stanley in the past week cut their view on third-quarter US gross domestic product to a gain of 2.9 per cent, from a 6.5 per cent increase.
Some of the flows into defensive sectors may have more to do with investors hunting for yield rather than worries over an impending market crash.
It’s been a wonderful ride for US equities … but moving forward we think it is going to be a little bit of a different picture.”
David Grecsek | MD in investment strategy and research and partner at Aspiriant
Defensive undertone
The S&P 500 Utilities index sports a yield of about 3 per cent, while the yield on the benchmark US 10-year Treasury note stood at around 1.33 per cent on Friday.
“The wall of worry does loom on the horizon … but the main reason defensive [stocks] are holding up relatively well is because of the income stream attached to them,” said Terry Sandven, chief equity strategist at US Bank Wealth Management.
Sandven, Nuveen’s Malik and Baird’s Mayfield all remain bullish on stocks, despite the market’s defensive undertone.
History may be on their side: the S&P has held on to a double-digit annual gain in eight of the last 10 years that it rose by 20 per cent or more in the period from January through August, as it has in 2021, according to a report from BofA Global Research. The exceptions were 1929 and 1987, which were both marked by historic market crashes.