Bullish investors taking high-level risks
The number of professional investors taking above-average risk is close to its highest level ever, according to Merrill Lynch’s latest monthly survey of global fund managers, even though more believe the world’s biggest stock market – the US – to be more overvalued than at any time since 2000.
A net 55 per cent are now overweight equities, despite rising valuations – global markets have surged since the middle of 2012, when a net 4 per cent were underweight stocks. Furthermore, they are underweighting defensive sectors and overweighting financial and tech stocks.
A year ago, managers were most overweight on emerging markets, which went on to become the worst performer of 2013, and loathed Japan – the big winner of the year.
Today, emerging markets (EM) are despised, with exposures near last summer’s lows, prior to a two-month relief rally. EM capitulation is close, says Merrill, adding: “Rarely have bullish growth expectations mixed with such bleak EM weightings.”
Although managers are right to note US markets’ rich valuation, their scepticism, coupled with high cash reserves, means any correction is likely to be “extremely limited”, says Merrill.
More at risk, perhaps, is Europe – the percentage of investors looking to overweight the region is the second-highest in the survey’s history.
With sentiment that bullish, indices are vulnerable in the event of a disappointing earnings season.
US markets are ‘overvalued’
Most valuation metrics confirm fund managers’ view that US markets are overvalued, as Marketwatch commentator Mark Hulbert noted recently. Hulbert examined six well-known indicators – price-earnings ratio, cyclically adjusted price-earnings ratio, dividend yield, price-sales ratio, price-book ratio, and the so-called Q ratio – and compared the S&P 500’s current readings with those that occurred at 35 market tops since 1900. In each case, the index looked pricier today than in the majority of the 35 market tops.
It confirms that US markets are “overweighted, overbelieved and overvalued”, as a recent Ned Davis Research report put it. So when might a double-digit correction ensue?
It is now more than 400 days since such an event, Société Générale’s Andrew Lapthorne noted last week – the eighth-longest streak on record. That doesn’t “necessarily imply impending doom” – there is “no relationship between time since correction and future returns”, Lapthorne says.
Overvalued markets can become more overvalued. The problem, Lapthorne says, is that extended runs can hide the real volatility in equity investing, and lead to higher risk-taking – a process that is already under way, judging by the aforementioned Merrill survey.
Gold-mining loses its lustre
Not all sectors have shared in the positivity. Gold lost 28 per cent in 2013 but that was nothing compared to gold-mining stocks – the world’s largest gold-mining company, Barrick Gold Corporation, more than halved in price and at one stage sank to a 21-year low.