With the S&P 500 (.SPX) making a new high again last week the obvious worry is that investors are getting overenthusiastic, as cheap money shields them from the real-world problems of a weaker economy, increasingly dangerous global politics and a poor profits outlook.
But glance at the stocks that are leading the market and there’s no obvious signs of exuberance. Instead, investors are cautious, confident only that the Federal Reserve will provide enough help to protect them from recession.
The problem is so familiar it has its own acronym: TINA, or There Is No Alternative to stocks. With 10-year Treasury yields again testing 2% and futures priced for at least two and probably more U.S. rate cuts this year, where else can you go but stocks?
The obvious answer for anyone deeply bearish is to buy bonds in spite of the low yield, because 2% is great if share prices crash. Cash is another alternative, adding the flexibility to buy back in if the stock market tumbles.
But it is hard to be confident that recession is imminent, and investors are dispirited rather than depressed. The U.S. economy might have slowed, but all the signs are that it is still growing. The oft-cited recession indicator of an inverted yield curve—that is, a 10-year yield lower than the three-month yield—has had long and unpredictable lags when it has worked in the past, and there are some reasons to think its predictive powers may be lower now.
“We don’t see ourselves in a recessionary environment yet, so we’ve got to stay invested,” says Fiona Frick, chief executive officer of Swiss fund manager Unigestion.
It is also very hard to be excited by the prospect of piling on risk. So the search is on for nice safe stocks that won’t suffer too much if everything goes pear-shaped, but will still do better than bonds if the “meh” economy keeps stumbling along.
That has pushed defensive strategies to the fore. Over the past 12 months investors would have been better off in Procter & Gamble (PG), Johnson & Johnson (JNJ) or Walmart (WMT) than any of the FANGs of Facebook (FB), Amazon (AMZN), Netflix (NFLX) and Google, now Alphabet (GOOG), although Microsoft (MSFT) has done well.
The same goes for sectors. From the last S&P 500 closing high at the end of April, four of the five sectors to beat the wider market were defensive: real estate, utilities, health care and consumer staples. The fifth, materials, is usually sensitive to economic cycles but was helped a lot by including a big gold miner, whose stock jumped along with the gold price.
Bigger stocks are doing better than their smaller, riskier, brethren. Stocks with stronger balance sheets and better earnings are ahead of their more-leveraged, more speculative rivals. And stocks that swing around less are doing better, too, rare in a rising market.
The natural pushback is to say that these measures are distorted, because so many of the big technology stocks are flush with cash. The five most-valuable companies in the U.S. are Microsoft, Amazon, Apple (AAPL), Alphabet and Facebook. Yet, only one of those has passed last year’s high, and the latter three are still more than 10% below their highs.
It is good news that investors aren’t wildly optimistic, because a boom-time mindset tends to be a precursor of poor returns. But valuations are on the high side, and there’s plenty of scope for genuinely bad news—conflict with Iran, further trade disappointment, a no-deal Brexit, tighter tech regulation—to hit stocks, even though these are risks investors are well aware of.
Perhaps as bad for stocks would be if the one thing investors are relying on didn’t appear, and the Fed chose not to cut rates. Worse than a central bank papering over the widening cracks in the global economy is one that lets investors think the cracks might be a sign of deeper structural flaws.
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