The US market is trading at record levels, yet a range of concerns—from geopolitical tensions and inflation to divisions within the Federal Reserve—are suppressing investor risk appetite. Paradoxically, this may be exactly what the rally needs to sustain itself.
The pace of new capital flowing into passive investment vehicles is slowing. Week after week, sentiment data shows that market bears outnumber bulls. Meanwhile, stock positioning levels fail to reflect the robust growth in corporate earnings. Taken together, this suggests a sense of calm is prevailing among investors—a healthy development after the S&P 500 Index has surged 22% since the end of March. With the economy and corporate fundamentals still solid, such caution implies there is still plenty of buying power waiting in the wings.
"It's arguably the best earnings environment in economic history," said Mark Hackett, chief market strategist at Nationwide, in a phone interview. "You have to be very creative to come up with a bearish argument."
The S&P 500 broke above 7,700 for the first time last week and has been setting consecutive records. Investors are buoyed by the second-quarter earnings season, which showed a 32% profit surge for index constituents in the three months through June—a growth rate that has only been exceeded in the early stages of major economic downturns.
Large money managers have been slow to react to this trend. Data compiled by Deutsche Bank shows that large-cap stock positions are currently at the 87th percentile of observations over the past decade. Strategists at the bank, including Parag Thatte, wrote in a note to clients that this reading typically corresponds to an earnings growth rate of around 15%, well below current levels. Separate data from the American Association of Individual Investors reveals that bears have outnumbered bulls for 20 of the past 25 weeks—a stretch this persistent last seen after President Donald Trump imposed global tariffs.
Data from Baird Strategas shows that investors poured about $31 billion into US stock ETFs last week, down from the pace of inflows seen when the market last hit a record high in early June. Of course, it's not hard to understand why skeptics remain firm in their stance. The shadow of rising interest rates threatens corporate earnings, while the Middle East conflict and the November US midterm elections remain unpredictable variables.
A sentiment survey from Bank of America indicates that strategists advise investors to allocate approximately 56% of their portfolios to stocks, below the 70% level seen from 1999 to 2007. "Stock positioning is not as extreme as it was in some previous cycles," said Jill Carey Hall, a US equity and quantitative strategist at the bank, in a phone interview. If history is any guide, the mismatch between investor sentiment and market fundamentals could present a buying opportunity.
Strategists at 22V Research highlight a gap between the AAII bull-bear spread and the firm's own US Economic Data Index, which tracks overall economic data releases. The current level of this gap suggests the S&P 500 could rise 1.6% in the next month, 5.1% in three months, and 7.8% in six months. "Relative to the economic data, current investor sentiment readings imply above-normal returns," wrote Dennis DeBusschere, president and chief market strategist at 22V Research, in a note to clients.
Alastair Pinder, a global equity strategist at HSBC, said, "Over the past few weeks, investors have had plenty of reasons to question the bull market in stocks. We believe these concerns are increasingly being priced into the market, while the market continues to underestimate the improvement in fundamentals."
Comments