The S&P 500 is up 12 percent so far this year. Through July, it had its best first seven months since 2003 and its second- best seven-month run since 1998. That sounds like a bull market.
But there is clearly a disconnect between the way markets have performed and the high level of caution among many investors. That is mainly due to the perception that things have the potential to go horribly wrong – incredibly fast.
The danger for investors is that they focus too much on the potential risks, such as the break-up of the , and end up getting left on the sidelines when markets move higher as they have done since the start of June, said Doug Cote, chief market strategist at ING Investment Management, in New York. “We are in a bull market,” he said. “The mistake investors have made is too much attention on global risk, and not enough attention on fundamentals that are very resilient.”
Cote believes that record high aggregate for S&P 500 companies this year and signs of improvement in the labor market mean investors should be taking on more risk rather than fretting about the dangers stemming from Europe’s debt crisis.
NO EASY CHOICES: But for the more equivocal souls, the market is presenting a difficult dilemma, and strong convictions either way are elusive.
David Joy, chief market strategist at Ameriprise Financial in Boston, says it’s an uncomfortable time for many investors, who are caught between missing a rally and getting blindsided by some nasty event that sends markets into a tailspin. “It’s a dilemma that is uncomfortable to watch and to function in,” said Joy, who helps oversee $571 billion in assets. “It’s one of those markets where you’re running a big risk being out.”
Joy says the rally is being driven by the hope of more “easy money” policies from central banks in the United States, Europe and. He has had doubts about the strength of the economy for many months. At the same time, he has been worried by the recent spate of cautious outlooks from corporate managers. But he also knows what investors ignore at their peril: “You can’t fight the Fed.”
“I don’t like the fundamentals, I don’t like what I’m seeing economically, I don’t like what I’m seeing in terms of earnings forecasts going forward, but I recognize that central banks can trump all of those things,” Joy said. “You may be right on the fundamentals, but wrong on the price action of the market.”
CAUTION CUTS BOTH WAYS: But Joy is also cautious about what many are describing as early signs of stabilization in the U.S. economy after a soft patch earlier in the spring and summer.
The July nonfarm payrolls report, which showed U.S. employers had done the most hiring in five months, is not enough to convince investors like Joy who want to see more confirmation before unwinding their defensive stance and getting more aggressive.
That cautious view that led him to cut his bond-equity allocation and lean more toward defensive areas of the stock market, such as consumer staples, healthcare and utilities, helps explain an oddity of the market’s rally since June. Much of the money heading into U.S. equity markets over the last two months has been heading into defensive sectors, some of it in a flight to safety from overseas markets, especially Europe.
Of two classically defensive sectors – utilities and telecoms – the utilities sector is trading at a 24 percent premium to the S&P 500, compared with an average 5 percent discount over the last 10 years, while the telecom sector is trading at a 50 percent premium compared with the usual 5 percent, according to data cited by UBS Wealth Management.
For Jeremy Zirin, UBS Wealth Management’s New York-based head of U.S. equities and chief U.S. equity strategist, that is both a red flag highlighting the market’s misgivings and a potential opportunity, should that differential start to narrow. “We have a bit of a pro-cyclical tilt in our sector strategy within U.S. equity markets, largely because the market seems to be positioned so defensively,” Zirin said. “We have seen this flood of flows going into defensive safe havens with high yield, and we just think they are very highly priced.
