Markets tend to veer between two extremes: fear and greed. But right now, the dominant emotion appears to be confusion.
This may seem strange. After all, global equities have just notched up their best month in more than three years, as the panic that gripped investors in December has dissipated. The bond market has also clawed back most of the losses it suffered last year, helped by the US Federal Reserve’s abrupt decision to pause interest rate increases and willingness to re-examine how quickly it will sell its bond holdings.
And yet, many investors admit a gnawing and growing unease. Where once there was certainty — whether bearish or bullish — there is now mostly doubt and indecision. As one top hedge fund manager says: “No one has a view, and everyone is positioned accordingly.”
Some think the new year rally will fizzle out, but are too cautious to bet on it given how painful being in cash or “short” can be if markets keep climbing. Others think another extended bull run is on the horizon, but are still nursing the wounds inflicted by 2018 and fear being pummelled should turbulence return.
It is hard to quantify uncertainty, but there is plenty of anecdotal evidence that it is prevalent. The trading volume of FTSE All-World stocks nudged higher in January, but it was roughly a third lower than the post-crisis monthly average, and this has been one of the least active starts to a year since the financial crisis.
DWS, an asset management group, uses a “value-to-fear” index constructed from the S&P 500’s (.SPX) trailing price-to-earnings ratio and the Vix volatility index, and after veering from euphoria to panic last year it is now firmly in ‘no man’s land’. Vix itself has calmed down, falling back to its early-October level, but the curve of Vix futures contracts is unusually flat, indicating some trepidation.
Wall Street analysts also lack confidence. Bank of America’s (BAC) Sell Side Indicator — which measures how optimistic strategists are on stocks — has climbed, but is caught in the middle of levels that typically indicate people are too bullish or bearish. The bank’s latest investor survey revealed few see a recession coming, even though their expectations for global growth and corporate earnings are at their weakest since 2008.
Hedge funds surveyed indicated they have reduced leverage to the lowest level since 2010. Judging by their implied market exposure and option prices, Macro Risk Advisors reckons hedge funds are playing defence in the way they last did in the 2008-13 market environment.
This is natural, with a panoply of risks on the horizon — such as US political chaos, trade wars, Brexit, European cohesion and China’s slowdown — and a murkier economic backdrop. An “economic policy uncertainty index” constructed from the dispersion of forecasts and newspaper reports has climbed to a record high.
Of course, this uncertainty shouldn’t be overstated — and certainly not after January’s welcome market bounce. Trends will emerge to replace old ones, and smarter traders will be able to find them while poorer ones languish. But for now, confusion is king.
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