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Markets and finance thrive on sounding clever, but over snacks and wine at a recent event, several professional fund managers admitted that their grand investment thesis at the moment is this: The market wants to go up. Don’t overthink it.
Sure, it’s no good talking about “the market” as if it were a person. No, that’s not a very sophisticated analysis. But it’s the prevailing worldview these days, and Goldman Sachs said this week that its Risk Appetite Index, a measure of appetite for risk across a wide range of asset classes, is nearing its highest level of 2021 and heading for its highest level since 1991.
That upbeat mood tends to make market participants uneasy, as it smacks of complacency and prices in greater vulnerability to shocks in growth, interest rates or other factors that move asset prices.“This could act as a speed limit for risk assets heading into the summer,” the bank’s analysts said.
They weren’t wrong: Stocks fell sharply in the hours after the report was released. Even the glow from another astounding earnings report from semiconductor giant Nvidia wasn’t enough to offset new strong U.S. economic data that again dashed hopes of a rate cut.
The overheating US economy is the biggest dark cloud currently hanging over the markets. Investors are getting used to the idea that interest rates may not fall in the US this year, a humiliating reversal from when multiple rate cuts seemed certain earlier this year. What investors are not yet prepared for is rising interest rates. We are uneasyl y edging closer to the point where rising interest rates become a serious prospect, but we are not there yet. So, despite the volatility this week, it feels like fund managers’ fingers are constantly hovering over the “buy” button.
For example, in mid-May, stock prices soared to new all-time highs after only a slight drop in the U.S. inflation rate. Consumer Price Index inflation fell to 3.4% in April from 3.5% in March. This is not a convincing return to the sweet deflation that fund managers love. But the slight slowdown was enough to propel the S&P 500, which is made up of U.S. blue-chip stocks, into new territory. The corporate bond market remains in high demand, and the yield gap between credit and government bonds is narrowing more and more. The gap, or spread, may be small, but all-in yields on U.S. 7- to 10-year maturities are over 5%, more than enough to attract the interest of professional investors and newcomers to credit.
Of course, if you want to actively avoid looking on the bright side of life, you can. Albert Edwards, the perpetual bearish chief executive of Societe Generale, has slammed the Federal Reserve, arguing that it is “sowing the seeds of yet another policy disaster.”
“In my view, prolonged monetary tightening is, quite simply, insanity in that it is forcing goods inflation into deep deflation in order to balance rising services inflation,” he said. “This is comparable to the catastrophic policy error of central banks in keeping monetary policy ultra-loose for 25 years before the pandemic.” That’s not going to satisfy some.
And sure, those who believe the Fed is incompetent, or that the U.S. is hurtling toward a fiscal crisis, or even that the dollar is losing its status as the world’s reserve currency, may be right this time. Maybe the surge in gold prices really is saying something. But by definition, none of these tail risks are imminent or likely to occur.
Even Morgan Stanley’s Michael Wilson, one of Wall Street’s most vocal bears, raised his 12-month target for the S&P 500 to 5,400 from a modest but significant decline of 4,500. Skeptics may see this as a sign of contrarianism, given Wilson’s long history as a bear, but others who have been more optimistic about the market for some time are also raising their targets. UBS’s chief investment officer also raised his end-of-2024 target for the S&P 500 to 5,500 from 5,200. He also sees the index hitting 5,600 by the middle of next year.
Geopolitical shocks that could dampen 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 proven unable to take the shine off stocks. What’s not to like?
Matt King, a former City investor who now runs Satori Insights, still urges a bit of caution. “The problem with momentum-driven markets is that momentum and FOMO are [fear of missing out] “That is often the only thing driving them,” he said in a recent note. “Yet it is enough to override all other considerations and potentially inflict substantial pain on anyone who dares to take a value- or fundamentals-driven short, but it still creates a fundamental vulnerability.”
Maybe, but as my wine companion argued, the market wants to go up, and the tension between this basic but powerful instinct and the threat of rising interest rates will determine how markets move for the rest of the year.
katie.martin@ft.com
