Maybe It’s Time to Start Worrying About Euphoria in U.S. Stocks
(Bloomberg) -- Mom and pop are rushing back to risk. The ultra-rich want in. Positioning in bellwether mutual funds has virtually never been so bullish. This as the S&P 500 has surged 11% in less than three months.
Word is getting around about stocks, music to the ears of anyone who sells or manages them. But if you’re the type of market contrarian who thinks a better backdrop for gains is gloom, all the elation is worrying.
“Investors jump on momentum and ride the rally and then become convinced that it’s going to continue forever,” said Aron Pataki, a portfolio manager at Newton Investment Management, which overseas about $62 billion in assets. “Typically, there is euphoria before pullbacks.”
Not that enthusiasm isn’t warranted. The S&P 500 is up 30% this year with dividends. People who stress about euphoria can sound like they’re complaining about a rising market. It’s just that over the long term, enthusiasm hasn’t been the fuel that drove U.S. equities to a $25 trillion bull run.
The latest survey of fund managers from BofA Global Research showed “the bulls are alive,” according to a Dec. 17 report. Expectations for global economic growth jumped the most on record, while investor allocations to equities rose to the highest level in a year. Meanwhile, the firm found cash levels among those surveyed are the lowest in six years.
A December analysis of institutional investors from RBC Capital Markets also showed optimism flowing over. People describing themselves as “bearish” dropped to 15%, the lowest level since the third quarter of 2018, before the rout that sent the S&P 500 down 19.8%. At the same time, the ranks of bulls swelled, creating the largest gap between optimists and pessimists since RBC began collecting the data.
“The bulls have broken out and the bears have gone into hibernation,” wrote strategists including Lori Calvasina, the firm’s head of U.S. equity strategy. “If the market keeps grinding higher in the very near-term, these are likely to be important sign posts that will eventually help mark the top.”
Positioning among tactical mutual fund investors is nearing extremes. Jason Goepfert, the president of Sundial Capital Research, tracks the Rydex family of funds, and traders who use the products “have almost never been more bullish,” he says. In fact, a composite reading of different Rydex positioning measures ranks in the top 4% of all readings over the past quarter-century. Market watchers have followed the so-called Rydex Ratio for years, since the funds reported their asset levels and their clients actively trade.
Still, Goepfert notes that the signal isn’t as strong as it used to be, since investors have migrated to exchange-traded funds. But Bloomberg Intelligence data show burgeoning bliss across the $4 trillion ETF industry, too. All year long, flows into fixed income ETFs have trumped those into equity funds. That is, until now. In the fourth quarter, stock ETFs have taken in $75 billion, more than two times the amount that’s entered bond funds.
“Tons of our ultra-high-net-worth clients are calling and saying: I missed this, how do you get me in with low risk?” said Matthew Peron, chief investment officer for City National Rochdale, which oversees roughly $40 billion. “You are seeing some froth.”
Again, some optimism is far from indefensible. Global economic data has shown signs of bottoming and a strong U.S. labor market should keep consumers spending. The Federal Reserve has vowed it’s on hold after three 25 basis point rate cuts this year, and is expanding its balance sheet by the week. Bloomberg Intelligence strategists led by Gina Martin Adams don’t see the latest run as the kind of doomed, over-heating melt-up that should elicit worry.
In those kinds of spikes, optimism usually separates from fundamentals, and sentiment drives returns. But corporate profits are expected to rebound next year and the S&P 500’s cyclical adjusted earnings ratio, a valuation multiple based on 10-year earnings also known as CAPE, “may point to improving equities’ value in coming years,” Martin Adams said. The S&P 500 average daily returns and volatility are a little too low to panic over, she added.
Underneath the headline index level, however, more froth is visible, according to Michael O’Rourke, JonesTrading’s chief market strategist. Since early October, 72 companies in the S&P 500 have rallied more than 20%. Tesla Inc. has surged more than 60% over that same time period. Semiconductor company Qorvo Inc. has too, while Apple Inc. has added $225 billion in market-cap -- close to the equivalent of Coca-Cola Co.
“That’s how I know there’s euphoria out there,” O’Rourke said by phone. “The problem is, because of the mechanical nature of the market, I can’t say that this is the end of the move.”
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