Traders Face Facts as $1 Trillion Loss Leaves Bears Bragging

(Bloomberg) -- It’s episodes like these that make equity bears feel validated.

Just last week, the stock market’s ascent seemed confident and hard to break. It was tough to make a case for pessimists like Newton Investment Management’s real-return team, which cited the lack of economic recovery as reason to have a record-low position in equities. Just days later, the rest of the market is paying more attention to the doomsayers.

Stocks across the world plunged at the start of October, putting a stop to a rally that had taken them near record highs. A stream of weak U.S. and European economic data has sparked concerns among investors that monetary stimulus may have come in too late to halt a downturn in growth.

“Things are very fragile and could be quite volatile as we go into the year-end,” said Suzanne Hutchins, a portfolio manager at the BNY Mellon-owned Newton, whose $16 billion real-return team in August slashed equity exposure to about 10%. “What is quite surprising is the complacency in the market. It’s as if people have become completely immune to the risks out there because equity markets are at an all-time high,” she said in an interview in London.

This week’s sell-off that wiped out more than $1 trillion from global equities was a troubling deja vu of the same time last year, when worries about higher interest rates and a potential U.S. recession spiraled into the S&P 500’s worst quarter since the 2008 crisis. On Wednesday, European stocks fell the most since December and Britain’s FTSE 100 saw its worst decline since 2016. The drop also undid weeks of gains in U.S. equities, returning them to August levels.

“It’s a paradox to have such strong cyclical concerns together with an equity rally,” Roland Kaloyan, the head of European equity strategy at Societe Generale SA, said by phone. “So what happened this week was a catch-up with reality. We are at the end of the cycle. European and U.S. equities will drop before the end of the year and now is a good time to lock in profits.”

But several factors signal that the bull market may not be over just yet. Going into the recent retreat, the positioning in stocks was far from overly optimistic despite near-record index levels, because equity funds have seen $200 billion of almost non-stop outflows this year. Also, options data show that market participants built up protection against losses during the September rally, limiting the damage from the slide.

Some bears are turning more optimistic on equities as a result of the sell-off. Alberto Tocchio, chief investment officer at Colombo Wealth SA, who had been underweight stocks over the past 10 days, says this week’s drop was a “feast” for his returns. He believes that fund outflows have gone too far and stocks have the potential to rally before the end of the year.

“While we were expecting this correction, it’s not all gloom and doom,” said Tocchio, who is now cutting the fund’s bond exposure. “I actually believe that by the end of this month we will have the ultimate opportunity to participate in the year-end rally.”

The key fuel for this year’s powerful equity rally was the resumption of rate cuts and monetary stimulus by major global central banks. Citigroup Inc. strategists expect their support to continue boosting risk assets next year.

All eyes will be on Friday’s U.S. payrolls report to gauge just how widespread the economic weakness has been after data on Thursday showed that filings for U.S. unemployment benefits rose to a four-week high. HSBC Private Bank’s chief market strategist Willem Sels said clients this week have been asking more questions about the chances of a U.S. recession, but few believe it’s the base-case scenario.

Stocks were struggling to find direction on Thursday, as the S&P 500 added 0.2% and the Stoxx Europe 600 closed little changed, despite whipsawing in late trading.

For now, Newton’s investment specialist Catherine Doyle says this week’s drop in equities isn’t large enough to get back into stocks, but the team is looking for attractive entry opportunities.

“We are watching closely to see if there will be contagion in the consumer or services part of the economy, which has so far been relatively resilient,” said Doyle. “Were this data to tip the economy over into a broad-based recession, there would be more serious reasons for concern.”

--With assistance from Michael Msika.

To contact the reporter on this story: Ksenia Galouchko in London at kgalouchko1@bloomberg.net

To contact the editors responsible for this story: Blaise Robinson at brobinson58@bloomberg.net, Celeste Perri

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