Stocktake: Proinsias O’Mahony

Investors sceptical of low-conviction rally With global equities gaining 15 per cent and Wall Street staging its eighth largest intra- quarter reversal in history, you might think there would be a whiff of investor exuberance in the air. Far from it: investors remain deeply sceptical of stocks' V-shaped rally.

Merrill Lynch’s latest monthly fund manager survey reveals that cash levels have actually risen over the past month, to 5.4 per cent. It’s rare for cash levels to spike higher during a rally. Even more extraordinary, the latest reading is barely below February’s 15-year high of 5.6 per cent.

Meanwhile, equity allocations remain well below-average levels.

Ordinary investors share this scepticism; retail sentiment surveys show bullishness remains muted, while investors have pulled money from equity funds and into bond funds in each of the past four weeks.

Contrarians will know this has bullish implications. Bull markets climb a wall of worry, topping out when everyone is fully invested. Any unexpectedly good news in coming months is likely to persuade fund managers to dip into their growing cash piles. Valuations may limit upside Sentiment is just one factor influencing markets, of course. Valuation is another, and one that is concerning investors: the percentage of fund managers who believe both equities and bonds to be overvalued is the seventh- highest reading in 13 years.

Their caution is understandable. The S&P 500 trades on almost 19 times trailing earnings. Over the past six years, investors have continually baulked at paying more for stocks than the current multiple.

That is unlikely to change; two savage bear markets since 2000 mean investors are all too aware of the dangers of buying into elevated markets. For equities to go higher, earnings need to go higher.

That’s why Merrill deems current high cash levels to be only “superficially bullish”. Valuations look “toppy” while the positioning buy signals seen in February have faded.

JPMorgan, too, is cautious. Markets were pricing in a shallow recession in February, but just as investors "had to stretch reality" to justify such pessimism, the same may be true of today's prices, which sit just below May's all-time highs.

Negative sentiment, then, may limit any downside, but high valuations mean market upside may be similarly limited from here.

Bulls look for turnaround Bulls' best chance of sustained upside is a turnaround in corporate earnings. With earnings season underway, will evidence emerge of the long-awaited profits rebound?

The current earnings recession means expectations were extremely low coming into earnings season, with estimates scaled back by 9 per cent in recent months.

That’s not quite as dire as it sounds. Heady analyst estimates are usually slashed as the reporting date nears; such a pattern has occurred in 24 of the last 30 quarters, according to Goldman Sachs. Lo and behold, companies then trump these lowly estimates.

Bulls believe this season’s earnings beat will be even bigger than usual. Current estimates were made when recession fears abounded, while the recent oil strength and dollar weakness may also boost both earnings and guidance.

Encouraging early reports are consistent with this thesis. It’s also notable that the pace of analyst estimate cuts has slowed for the first time in eight months.

How much of this is already priced in is the key question. Predicting improved company earnings is one thing; predicting the market reaction is an altogether trickier matter.

Investors not bothered by Brexit Merrill's fund manager survey also shows that the possibility of Brexit is "the second biggest tail risk keeping global asset allocators awake at night", FE Trustnet reported last week.

That’s one way of putting it. A more appropriate conclusion might be that investors are far from bothered about the referendum – the survey shows that just 14 per cent believe Brexit is likely.

Brexit is unlikely, although it’s far from impossible – most bookies will give you odds of less than 2/1. StockTake suggested last week that markets appeared oddly nonchalant about the prospect, and Merrill’s survey confirms that thesis.

As Rabobank's Piotr Matys cautions, it might be wise to expect "yet another classic 'five minutes to 12' reaction, when risk aversion suddenly escalates significantly just a few weeks/days ahead of the referendum."

Stale tweets move stock prices Twitter moves stock prices, an Oxford study has concluded, even when unaware investors are simply re-tweeting stale news stories.

Volatility escalates by about 50 per cent in the most-talked about stocks on social media, the study found. Instead of dying down, it remains very elevated over the coming month.

This is a purely online phenomenon – stocks with the most coverage in conventional media show subdued volatility and trading volumes.

The obvious explanation is that stock prices are being driven by online “buzz” around stale news, with some investors treating repeated information “as though it were new”. See http://goo.gl/7vc2yA