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Markets and finance thrive when they sound smart. But over drinks at a recent event, a number of professional fund managers admitted that their big investment thesis at the moment is this: the market wants to go up. Don’t think about it too much.
Yes, it is bad to talk about “the market” as if it were a person. No, it’s not a very sophisticated analysis. But it’s been a widespread worldview lately, so much so that Goldman Sachs said this week that its Risk Appetite Indicator — a measure of enthusiasm for risk across a wide range of asset classes — was close to its 2021 high, and on track was to the highest setting. highest level since 1991.
Such a cheerful mood often makes market nerds nervous. It smacks of complacency and creates additional vulnerability to shocks from growth, interest rates or any of the other factors that push up asset prices. “This could impose a speed limit on risky assets into the summer,” the bank’s analysts said.
They weren’t wrong. Hours after the report was published, stocks pulled back significantly. Even the shine of another set of great results from chip giant Nvidia wasn’t enough to offset another dollop of strong US economic data, which has once again lowered expectations for rate cuts.
An overheated US economy remains the biggest cloud hanging over the markets at the moment. Investors are getting used to the idea that U.S. interest rates may not fall this year, even if that marks a humbling reversal from what was seen early this year as an entrenched certainty of multiple cuts. What they are not ready for is interest rate increases. We’re getting uncomfortably close to the point where that becomes a serious prospect, but we’re not quite there yet. So despite this week’s swing, it still feels like fund managers’ fingers are always hovering over the buy button.
In mid-May, for example, it only took a small decline in US inflation to send stocks shooting to new all-time highs. Consumer price index inflation fell from 3.5 in March to 3.4 percent in April. That’s hardly a convincing return to the sweet, sweet disinflation that fund managers love so much. But the slight slowdown was enough to send the S&P 500 index of top U.S. stocks into new territory. The corporate bond markets remain in high demand, causing the gap in returns between corporate bonds and government bonds to narrow. The difference, or spread, may be small, but the all-in return, at over 5 percent for US maturities of seven to 10 years, is still more than enough to keep specialist investors and new lenders interested.
If you want to actively avoid looking at the bright side of life, you can of course do so. Société Générale’s permabear-in-chief Albert Edwards is railing against the US Federal Reserve, arguing it is “sowing the seeds of yet another policy disaster.”
“In my view, any longer tightening is just crazy, simply because it is now pushing goods inflation into deep deflation to offset higher services inflation,” he said. “It coincides with the central bank’s catastrophic policy mistake of keeping monetary policy super loose for the 25 years leading up to the pandemic.” Some people are not satisfied.
And those who believe the Fed is incompetent, and/or that the US is headed for a fiscal crisis, and even those who believe the dollar is on the verge of losing its status as a global reserve currency, could be right this time. Maybe the sky-high gold price really tells us something. But by definition, none of these tail risks are imminent or likely.
Even Morgan Stanley’s Michael Wilson, one of Wall Street’s most outspoken bears, has raised his 12-month target for the S&P 500 from a paltry and deeply underwater 4,500 to 5,400. Cynics might consider this a contrarian indicator given how long Wilson stuck to his bearish strategy, but others who have been more bullish on the market for a while have also flipped the switch. UBS’s chief investment office also raised its 2024 year-end target for the S&P 500 from 5,200 to 5,500. It also expects the index to reach 5,600 by the middle of next year.
Geopolitical shocks that could undermine risky markets, such as the sudden death of Iran’s president in a helicopter crash or China’s hostile rhetoric toward Taiwan’s new leader, have failed to take the shine off equities. What’s not to like about it?
Matt King, formerly of Citi and now director of Satori Insights, cannot resist being a little cautious. “The problem with momentum-driven markets is momentum and Fomo [fear of missing out] are often the only thing that drives them,” he said recently in a note. “That may still be enough to trump all other considerations, and inflict significant pain on anyone who dares attempt a value- or fundamentally-driven short, but it nevertheless creates an underlying vulnerability.”
Maybe. But as my wine-drinking companions argued, the market wants to go up. The tension between this basic but compelling instinct and the specter of higher interest rates will determine how markets behave for the rest of this year.
katie.martin@ft.com