(Bloomberg) — Like stuck-up card players trying to win it all back in one hand, stock bulls are picking up their risk appetites at the end of a brutal year.
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Active fund managers are added to the positions. Options markets are trending towards hedging, a sign that professional traders are pulling back into stocks. Demand for meme stocks outside of institutional circles is forever on the rise, with chat room favorites like AMC Entertainment posting big days.
Fueling the momentum, as usual, is speculation about a policy change at the Federal Reserve — hopes for several times on Friday when U.S. hiring and wage growth forecasts rose in the past. While changes in market leadership may point to a more solid future for a rally that has sent the S&P 500 up 14% since October, it’s hard to separate the recent bull run from the collapse earlier this year.
“You have a difficult market in terms of understanding that conditions are still relatively difficult, where people are hoping for some signs of respite,” said Lisa Erickson, senior vice president and head of the public markets group at US Bank Wealth Management. “We are more skeptical that this rally is sustainable regardless of which sector, which style is leading value or growth.”
The problem for bulls is that the latest resurgence in risk appetite is a perfect repeat of early August, when active managers and hedge funds doubled and tripled their exposure and meme stocks in some cases. The episode ended in disaster for the bulls, with the S&P 500 down more than 15% in eight weeks. Many experts see the potential for the same fate this time around.
In the latest move, shareholders were quick to latch on to Fed Chairman Jerome Powell’s comments about a possible reduction in the pace of tightening at next month’s meeting, leading the S&P 500 to rally 3% on Wednesday. That session overcame losses on each of the other four days, keeping stocks in the green for a second straight week.
More than $10 trillion was added to stock values in October as stocks retreated from bear market lows. Along the way, there have been familiar signs that money managers who previously cut stocks to the bone are warming up to the market.
Equity risk fell to its lowest level since the 2020 pandemic in September, according to a survey by the National Association of Asset Investment Managers (NAAIM). It has bounced since then and is now nearing a four-month high.
Hedging demand is back in options – a bullish signal given that nobody needs to hedge when they don’t own any stocks. After hitting a nine-year low in November, the S&P 500 curve, which measures demand for insurance by comparing the relative value of three-month puts to calls, has risen in three of the past four weeks, data compiled by Bloomberg show. .
“This may reflect increased hedging activity,” Susquehanna Financial Group strategist Christopher Jacobson said in a note this week. “This could be a constructive sign that more investors are adding to positions, gradually increasing demand as a result.”
The battered retail crowd has reawakened, at least when it comes to meme stocks. AMC Entertainment rose 9% for the week, while Bed Bath & Beyond Inc. and jumped more than 10%, snapping an 11-week losing streak.
Similar enthusiasm is not observed among the expert class. Citing everything from falling future yields to continued Fed tightening, strategists at firms from Morgan Stanley to JPMorgan Chase & Co have warned that the S&P 500 will test its 2022 lows next year. In a worst-case scenario, the team at Morgan Stanley sees the index hitting 3,000, or down 26% from Friday’s close.
Investors repeat the same basic drama all year. A bounce begins either amid oversold conditions or because of Fed expectations, forcing a short squeeze and prompting rules-based impulse traders to buy stocks. This leads to a charming, technically driven rally that has legs but eventually crashes. It was Chairman Powell’s Jackson Hole speech that dampened the euphoria in August. Two months ago it was a hot inflation print.
However, one difference stands out from the summer rally: market leadership. At the time, tech stocks led a rebound as investors snapped up beaten-down firms. This time it is in favor of stocks that look economically sensitive and cheap, such as raw materials and industrial producers.
“It’s less of a speculative fringe. Technology is not as involved,” said Art Hogan, chief market strategist at B. Riley Wealth. “This rally has more continuity because it’s broader.”
Amidst all the failed market bounces, institutional investors — pensions, mutual funds and hedge funds — pulled back. JPMorgan strategists, including Nikolaos Panigirtzoglou, estimate that their net capital requirement has fallen by $2.1 trillion this year.
This can pave the way for future advancement. The JPMorgan team’s model shows that if their positions return to their long-term average in 2023, that means $3.3 trillion in stock purchases.
The key question is whether these professionals are willing to increase their holdings in the face of a bleak outlook.
Bryce Doty, senior vice president at Sit Investment Associates, says his firm is in buy mode as Powell stops drawing parallels to the inflationary era of the 1970s and refrains from saying rates need to be high enough to destroy jobs.
“This is a major turning point or shift away from the myopic, dogmatic, damn torpedoes, full steam and demand destruction rhetoric,” Doty said. “I know the market will look a little choppy at times and things can be turbulent, but I left the buyout camp a year ago. I’m back.”
–With the help of Vildana Hajrij.
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