Bullish markets, bearish investors?

Since mid-May, the investment landscape has been subtly shifting. Interest rates continue to suffer from higher-than-normal volatility and doubts toward disinflation have taken the steam out of stock markets. Investors are holding onto cash, signaling bearishness, but risk-appetite indicators remain in bullish territory. This week, Simply put investigates this paradox and explains how our All Roads multi-asset strategy is positioning in response.
 

Taking a breather

The current equities hiatus is likely linked to persistently high inflation rates, which appear to be fostering doubts among market participants. Investors are beginning to question whether they should once again brace for central-bank resolve to quash inflation definitively. Opinions are divided: while some would see such action as a necessary intervention, others would view them as potentially overzealous. 

In this environment, it's intriguing to note that the markets themselves seem more optimistic than investors – a paradox that underscores the current complexity of global financial dynamics. This scenario presents a critical juncture. In classic 'All Roads' mode, we aim to navigate this uncertainty by balancing diverse investment exposures to align with the evolving economic landscape.
 

Bullish markets…

Since mid-May, the recovery from the April drawdown has stalled. This interruption is largely attributed to the publication of the US inflation report on 15 May, which sowed seeds of doubt in the investment world regarding the persistence of inflation – potentially longer than initially anticipated. This report challenged the notion of a ‘straight-line disinflation’, casting uncertainty on the resumption of a bullish trend after April's profit-taking. 

Is this the complete narrative? Perhaps not, in our view, especially when considering the risk appetite and trend indicators on our dashboard of signals. Risk appetite has been consistently bullish since last November, rarely dipping below the 60% threshold that marks a bull regime. Furthermore, as illustrated in Figure 1, our trend signals present what could arguably be the clearest picture of all: bullish trends on all risky assets and a bearish trend on duration. What more could one ask for a bullish market scenario?
 

… but bearish investors

However, as Figure 1 also depicts, not all investors are in sync with this bullish outlook. When examining the amount of cash held in money-market funds relative to US GDP for comparison, it's evident that this ratio remains high and has recently increased. This suggests that despite the recent risk-on rally, a significant portion of investors remains unconvinced. 

To put this in perspective, 21% of US GDP is currently held in money-market funds, compared to the peak of 24% during the 2020 pandemic and in stark contrast to the sub-15% levels seen in 2016-2017. This undoubtedly also reflects the shift in the nature of recent bull markets from TINA (there is no alternative) to TIAA (there is an alternative) as cash rates increased. 

Regardless, while market trends may appear bullish, they have yet to attract the broadest base of investors, many of whom continue to prefer the safety of cash. 

FIG 1. LOIM trend signals (left) and money market funds as a ratio of US GDP (right)

Source:  Bloomberg, LOIM at 31 May 2024.
 

What portfolio positioning to adopt?

In this environment, determining the appropriate asset allocation poses a significant challenge. On one hand, market trends appear generally supportive for cyclical assets such as equities, credit, or commodities, while bonds continue to struggle. On the other, the restraint of many investors might suggest that something crucial is missing – perhaps a perception that a kind of soft landing has occurred, which could restore confidence and encourage them back into the markets with more reasonable valuations. 

What is the best course of action when faced with such contradictory scenarios influencing both markets and investor sentiment? In our view, the answer lies in trusting our established process and the insights provided by our dashboard, making portfolio adjustments in response, as illustrated in Figure 2. 

The charts show the percentile evolution of asset allocation within our All Roads strategy for traditional markets (a high reading indicates a higher-than-usual exposure to markets broadly) and for hedging assets, which consist of derivatives strategies designed to benefit from a rise in market volatility. 

More recently, after a prolonged period of low participation in markets throughout 2022 and much of 2023, our strategies have increased their market exposure since November last year. Today, these strategies are positioned at 60% of their typical market exposure, which is higher than the average but not excessive. Additionally, there is an increased exposure to our volatility-based hedging assets, which are also currently at 60%. This balanced approach aims to capitalise on current market opportunities while maintaining a robust defence to navigate potential downturns effectively.

FIG 2. All Roads’ allocation to markets (left) and hedging strategies (right) 

Source:  Bloomberg, LOIM, as at 31 May 2024. Allocations subject to change.
 

What this means for All Roads

The primary insight from our dashboard is clear: the opportune moment to reduce cash holdings and increase market exposure emerged in the fourth quarter of last year. However, this adjustment was advised not to be at full scale and definitely not without the inclusion of hedges, in our view. 

In recent weeks, we discussed how unusually low volatility, influenced by specific flow reasons, currently makes hedged long positions particularly appealing. Our All Roads franchise currently occupies a strategic middle ground between two markedly different allocations: a full exposure and a controlled exposure. In our view, this nuanced approach suits the prevailing paradox in which market dynamics appear bullish, yet investor sentiment remains cautious.
 

Simply put, markets look more bullish than investors. This paradox needs to be resolved before market exposures in portfolios can be increased.

Macro/nowcasting corner

The most recent evolution of our proprietary nowcasting indicators for global growth, global inflation surprises, and global monetary policy surprises are designed to track the recent progression of macroeconomic factors driving the markets.

Our nowcasting indicators currently show:

• Growth declined again this week, driven by the down-trending US data
• Inflation pressures continue to build in the Eurozone and the US
• Monetary policy surprises are still more likely to take the form of rate cuts

World growth nowcaster: long-term (left) and recent evolution (right)

World inflation nowcaster: long-term (left) and recent evolution (right)

World monetary policy nowcaster: long-term (left) and recent evolution (right)

Reading note: LOIM’s nowcasting indicator gather economic indicators in a point-in-time manner in order to measure the likelihood of a given macro risk – growth, inflation surprises and monetary policy surprises. The nowcaster varies between 0% (low growth, low inflation surprises and dovish monetary policy) and 100% (the high growth, high inflation surprises and hawkish monetary policy).

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