UK Edition
Global funds think equities overvalued but keep buying, as US markets take a dive
Global fund managers say stock markets are more overvalued today than at any time this century, but are continuing to buy equities aggressively, betting the day of reckoning is a way off yet.
However, the turning point could come sooner than expected, with US markets on Tuesday suffering their biggest falls since Donald Trump’s election victory, driven down by investor fears that the president will not be able to deliver promised tax cuts which have helped lift equities to record highs. The Dow Jones fell 1.14pc and the S&P 500 lost 1.24pc.
Bank of America’s influential survey of investors for March shows that a net 34pc of funds believe that global stocks have risen too far, much higher than in the frothiest moments before the Lehman crash.
The chief worry is that rising interest rates could trigger the next bear market yet few believe that “synchronized monetary tightening” by the big central banks will hit this year.
Higher rates are deemed a bigger threat than weaker earnings or a surge in protectionism, a fading concern, but the broad view is that the coast is clear until US 10-year Treasury yields reach 3.5pc to 4pc.
A net 81pc think Wall Street is overvalued, an all-time high. Yet funds are hanging on to their overweight US positions for now, either constrained by the need to place money somewhere or because they consider themselves agile enough to exit the market just in time.
Almost 90pc doubt there will be a tax reform deal in Washington before the summer recess, and a third doubt that it will happen this year.
The closely-watched survey suggests that Brexit Britain is still loathed by global managers. Not even the slide in sterling is enough to lure them back. A net 30pc are underweight UK equities, an extreme divergence with other developed markets.
“Disintegration risk” in the eurozone caused by elections is the top worry, though most funds doubt that European stocks would fall by more than 10pc even if Marine Le Pen won in France. Some even think that equities would rise, a view deemed “complacent” by Bank of America.
A crash in the global bond markets remains a concern as inflation gathers pace. Capital flight from China and a yuan devaluation have almost dropped off the radar screen. Only the deflationary diehards still fret about ‘secular stagnation’. A net 65pc are underweight bonds.
Fund managers are not necessarily right about any of this. They are often wrong. Highly “crowded” views are watched by market veterans as a contrarian signal, evidence that the trend is reaching an extreme.
There is no guarantee that central banks will remain dovish. The US Federal Reserve has clearly sketched two more rate rises this year, while the European Central Bank is about to cut the pace of bond purchases from €80bn to €60bn a month. Europe’s "taper tantrum" could kick off at any moment.
A majority of funds expect Chinese growth to accelerate this year, an odd assumption as the fiscal boom of the last 18 months fades and the People’s Bank tries to rein in the credit bubble.
Bank of America’s Bull & Bear index for equities has not yet triggered a sell-signal. The ratio of cash holdings is still above the 10-year average of 4.8pc, indicating that there is still money on the side-lines.
The moment of danger is when cash falls to 3.5pc. The bank advises clients to stick to its blow-off "Icarus trade" for the time being, even if the overall slippage in "macro momentum" portends a pause over the next few weeks.
A net 39pc of fund managers think the dollar is too strong, the highest since 2006. Sentiment is shifting back to euro.
The chief rotation is out of energy and bonds and into emerging markets, deemed undervalued by a net 44pc. The rush to buy global technology stocks (+38pc) and banks (+29pc) is flashing warning signs.
The ratio of total stock market capitalisation to GDP is the best long-term indicator of value. It was roughly 50pc of GDP in the US in the 1980s. It peaked at 146pc in the dotcom bubble. Today it is 167pc. Clearly the air is getting very thin.