Equity and bond markets have once again been bounced around by the comments coming from members of the Federal Reserve. Last Friday Atlanta Federal Reserve President Rosengren spooked equity and bond markets. On Monday it was the turn of Lael Brainard to utter more soothing words of caution. According to the Financial Times this now leaves the bond market pricing in a 5/1 against chance of a move in September. This makes the possibility of Donald Trump becoming the next President, at 3/1 against, a more likely prospect than Janet Yellen and the Federal Reserve voting to raise rates.
We constantly go on about the lack of bullish sentiment in the equity market. Meryl Lynch’s latest fund manager survey suggests that fund managers continue to hold higher than normal levels of cash, as they have done for most of the year. Equity weightings are 1 standard deviation below historic norms; this still does not feel like the positioning that historically led to sharp falls in equity prices.
Barclay’s strategist’s view of equities is that they remain fairly valued against historic comparisons and certainly not at the extremes they get to at the start of previous bear markets. Barclay’s go on to point out that Fund flows have been severely negative. They also refer to cash balances looking elevated, analyst sentiment far less exuberant, and strategist consensus unnaturally conservative. According to their research only 46% of total ratings issued by the consensus of research analysts in Stoxx 600 are buy rated. These are all statistics you would expect to see towards the end of a bear market and in the teeth of an economic recession. Cyclical stocks continue to look more attractive than defensives.
What is the explanation for all this negative sentiment? Speculating, the first reason could be bull markets tend to run for 6 years, so this one being long in the tooth may explain part of the current psychology. The other probable cause is that part of the equity valuation story is based on the historic lows in bond yields, as central bankers continue to use blunt tools to stimulate the global economy.
As we saw this week any spooking of the bond market will immediately spook equity markets. No one can predict when this bond bubble will bust, they just sense it will. When it happens equity market valuations will adjust.
That is what makes everyone nervous of equity prices. The strange thing is that bond markets continue to see greater inflows than equity markets.