The relentless drive into defensive stocks is a logical way to cope for investors beset all year by signs a recession is at hand. It’s also a tough way to set a fresh stock record.
Buoyed by a supportive Federal Reserve and strong economic data, the S&P 500 climbed within points of an all-time high on Thursday only to falter as investors snubbed the growth stocks that underpinned the record bull run.
They clung to industries inured to economic cycles or that go up in lockstep with bonds, making real-estate and utility stocks – among the puniest of S&P 500 groups – the sole bearers of the rebound from August’s rout. Just about everything else is in the red.
After suffering through three different 2% plunges, the sight of an inverting yield curve and Donald Trump’s trade tweets, confidence that technology and consumer shares are set to rebound remains in short supply ahead of a batch of earnings set to show shrinking corporate profits. “People are nervous,” Peter Jankovskis, co-chief investment officer at Oakbrook Investments, said by phone.
“They see signs of optimism but they’re also wary that these things have broken down several times already. They’re putting their feet back in the water with names they suspect will hold up if these hopes aren’t realised.”
Even if stocks reclaimed their July highs, new records have been something less than an all-clear signal in the US stock market for almost two years. Since January 2018, the average overshoot has been 1.75% before things fell apart again.
Repeating that would lift the S&P 500 to 3,088. It closed the week at 3,009, about 15 points shy of a record.
That’s not to say there’s no reason for bulls to remain upbeat.
Economic data has started to improve. Stocks reversed losses on Wednesday after Jerome Powell said the economy needed only moderate easing but that the Federal Reserve was “prepared to be aggressive” should growth falter.
A recent rotation into value gave beaten-down stocks a lifeline. That’s helped the health of the market, with the aggregate advance-decline line for stocks listed on the New York Stock Exchange climbing to a record this month. Small caps, long laggards, have also rallied, with the Russell 2000 gaining about 4% this month.
“The market is still persevering,” said Kim Forrest, chief investment officer at Bokeh Capital Management in Pittsburgh. “Prices are holding in there more or less and that’s a good sign. And I think the reason behind that is the relatively strong economy.”
Still, it’s no wonder caution prevails amid the latest elevation. Hedge funds have resisted embracing the rally, raising bearish bets on stocks while keeping net exposure below average. At above 3,000, the S&P 500 would exceed the average year-end target of 2,952 from Wall Street strategists.
Consumer sentiment is also declining and, with it, worries over an oncoming recession have spiked.
The list of people lining up to ring the recession bell has expanded in recent weeks: Ray Dalio and Jeffrey Gundlach see chances of the next downturn increasing.
More than a third of respondents in a Bank of America survey say one is likely in the next year, the highest probability since 2011. A net 2% of those surveyed were overweight US equities, according to the bank.
“The financial markets are clearly indicating a slowdown, if not a potential recession,” Rich Weiss, chief investment officer of multi-asset strategies at American Century Investments in Mountain View, California, said by phone. “This can be viewed as what’s known as climbing the wall of worry, or can be viewed as the last gasp of the bull market. I think we’re somewhat in between.”
Investors have been willing to pay up for peace of mind. Electricity and energy stocks now trade at more than 20 times earnings, the most expensive valuation on record.
Earlier this month, utilities’ valuation premium over the S&P 500 touched the highest since 2007 and the S&P 500 utilities sector closed at a record this week.
Since the start of August, exchange-traded funds that track real-estate and consumer staples have each taken in more than $1bn, more than any other sector, according to data compiled by Bloomberg.
Last month, financial-focused funds lost near $4bn in cash, while investors also pulled more than $1bn from energy ETFs.
Demand has spiked for smart-beta products that aim to provide a smoother stock market ride. In aggregate, low-volatility ETFs took in more than $3bn in August, the most since December’s equity meltdown. Already this month, investors have rushed into the group faster than any other.