Stock Market Timers Pony Up $25 Billion And Get Another Beating
(Bloomberg Opinion) — For all its twists and turns, the 2022 market has also been a story of repeating patterns. Stocks fall, shorts cover, quants buy, then they all come back just in time to be set on fire.
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It’s happening again.
After a month of cutting positions, investors poured $25 billion into stocks in the week to Wednesday only to see the S&P 500 plummet as the Federal Reserve and other central banks maintained hawkish stances that threaten to spark a recession. The benchmark index ended the week with its worst three-day drop in two months, shattering chart support and putting it on track for its first December drop since 2018, when rate angst was wreaking similar havoc.
The latest bout of optimism was quashed after Chairman Jerome Powell reiterated that rates will go up and stay there until inflation falls sharply. Investors trying to catch up to a rally that added 14% from October lows untimely piled on last week hoping for a year-end rally. Instead, they find themselves in a long market where valuations remain stretched, earnings are expected to fall, and other assets like Treasuries are proving viable alternatives.
“We’ve seen significant downward dislocations in equities and risk appetite in general, every time the market has reinterpreted the Fed’s outlook, because every time it does, it gets more and more negative,” Alec said. Young, chief investment strategist at MAPsignals. In an interview. “Dip buyers have been waiting for peak inflation to lead to more dovish Fed policy, and it hasn’t quite worked.”
Stocks fell for a second week as economic data on retail sales and manufacturing signaled a slowdown, while central banks increased their hawkish stance. The S&P 500 fell more than 2%, breaking out of a five-week 200-point trading range and chipping away at its 100-day average for the first time in more than a month. For Chartists, the loss of support is a sign of more pain to come.
The renewed sell-off is the latest calculation for stock bulls who have spent the entire year buying the dip, to no avail. The S&P 500 has risen more than 10% from a low on two other occasions this year, in March and from June to August, and both succumbed to fresh selling that sent the market to new lows.
This time, the rally began in mid-October with a huge short squeeze on the heels of a red-hot inflation print. As asset gains gained momentum in November, rule-based traders were forced to accumulate, with trend-following quants buying $225 billion worth of stocks and bonds in just two trading sessions, according to an estimate. The fear of being left behind was so intense that tens of millions of dollars were spent on call options to catch up, adding fuel to the rally.
Fund investors who had been pulling money out of stocks for three straight weeks were finally getting back in. According to EPFR Global data compiled by Bank of America Corp., they added $25 billion of fresh money to US stocks in the week to Wednesday and returned a record high. $14 billion to value funds.
While this faith may one day prove prophetic, for now, the timing has been painful. In the last three sessions, 95% of the members of the S&P 500 fell, wiping out $1.4 trillion of the index’s value.
“The market had a really strong October and November, so there is a bit of trend following from investors, and many may think this is the start of a new bull market,” David Donabedian, CIBC’s chief investment officer . Private Wealth US, said in an interview. “I think there are more downsides here.”
Underpinning the latest rout was mounting angst over a looming recession, a threat the bond market has signaled for months through yield curve inversion and yet was dismissed by stock investors. Now, with the Fed raising its forecast for interest rate ceilings to 5.1% and cutting the forecast for gross domestic product to flat growth next year, reality is starting to sink in.
At 16.7 times forecast earnings, the S&P 500 valued at a multiple that is about one point above the 20-year average. And shares will become more expensive if earnings estimates continue to fall. Since June, projected earnings for 2023 have fallen 8% to $229 a share, data compiled by Bloomberg Intelligence shows.
Furthermore, rising interest rates are eroding a decade-long bull case for owning stocks, sometimes labeled “there is no alternative” or TINA. Some of the competition comes from cash. At the beginning of the year, when three-month Treasury bills offered almost nothing, some 390 companies in the S&P 500 could be seen as more attractive with higher dividend yields. After seven Fed hikes that brought the short-term government bond payout to 4.3%, the pool of stocks with higher-than-cash yields dwindled to no more than 55.
Another threat is fixed income. For example, consider an analytical tool known as the Fed model that compares the income stream from stocks to that from bonds. It shows that the S&P 500 earnings yield, the reciprocal of its price-earnings ratio, is now 1.9 percentage points above the 10-year Treasury rate. An increase in the 10-year yield from the current 3.5% to 5% would need earnings to expand about 28% to maintain the current valuation advantage, all else being equal.
“We’ve used the analogy: There’s a stock store and there’s a bond store for your holiday shopping,” Emily Roland, co-head of investment strategy at John Hancock Investment Management, told Bloomberg Television’s Surveillance. “The stock store, not much for sale.”
–With the assistance of Jonathan Ferro.
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