Here Are Five Tailwinds Set to Boost the Global Market RallyBy
Equity managers forced to catch up, benign positioning
Economic growth, tentative tax trade, limited credit supply
Financial markets are dancing again to the risk-on beat, with the latest upswing in global manufacturing the latest reason to boogie.
With the threat of higher interest rates, geopolitical shocks, and rich valuations, for now, seemingly powerless to unhinge stocks and bonds from their bullish foundations, there could be even more pain in store for naysayers.
Here are five forces that may fan the flames of the risk rally.
Equity Managers Play Catch-Up
This is the season for investors to be jolly. Discretionary macro hedge-fund managers and active mutual-fund managers are likely to chase markets since they are flat or have lagged benchmarks for the first three quarters, according to JPMorgan Chase & Co. Add outflows spurred by the boom in passive investing -- estimated to hit $254 billion this year, matching 2008 levels -- and active equity mutual funds are under strong pressure to chase performance, the bank reckons.
So far this year, equity long-short hedge fund managers haven’t delivered market-beating returns either, according to strategists at the U.S. lender. "If it materializes, such performance chasing could propel the equity market higher into the last quarter of the year," analysts led by Nikolaos Panigirtzoglou wrote in a note.
Far From the Madding Crowd
Bullish asset allocation in risk markets, from stocks to credit, may not be as stretched as you think. Investors pared exposure to long-dated emerging-market debt funds, for example, over the summer in anticipation of an uptick in developed-market government bond yields, according to HSBC Holdings Plc. That’s left money managers cash-rich and ready to pounce on selloffs, the bank says.
Investors in European investment-grade credit also have plenty of dry powder. Some 60 percent of money managers reported above-average cash balances, according to a JPMorgan investor survey conducted last month. Meanwhile, the average duration of portfolios has fallen to 4.6 years from 4.9 years at the start of the year, according to the bank’s analysis of 100 European high-grade funds.
That suggests they’re less exposed to interest-rate risk than those fully benchmarked to the iBoxx EUR Corporate Index, with a duration of 5.2 years.
And stocks could be ripe for more bullish positioning. Investors increased their hedging activity over the summer, fearing higher volatility over the autumn spurred by hawkish central-bank chatter. If such hedges are unwound -- and costly short-volatility trades pared back -- share prices could get more support, JPMorgan concludes.
While investors have gorged on new debt this year, net supply has been modest, after taking into account coupon payments, new inflows into global debt funds this year, and as a proportion of the outstanding market, more generally.
The latest sign: Banks are struggling to source new bonds, with dealer inventories of high-grade bonds at the end of last month at just $3.5 billion, down from $8.6 billion on Sept. 20.
"This lack of bonds available is the result of macro-conditions for strong demand –- i.e. ultra-low foreign core inflation -– still being intact as supply slows down seasonally and as issuers have front loaded more than $100 billion over the summer," credit strategists led by Hans Mikkelsen at Bank of America Corp. wrote in a note.
Modest supply is also set to keep the lid on high-yield spreads in Europe, according to strategists at HSBC.
New Economic Tailwinds
Global growth is faster, firmer and more synchronized than it has been in years. That rebound, albeit cyclical so far, is casting doubt on the view the U.S. economy is ensnared by secular stagnation. The latest sign: American manufacturing expanded last month at the fastest pace in 13 years, underscoring resilient global demand and U.S. capital spending, while adding momentum to the dollar and equities.
Nomura Holdings Inc. is one critic arguing the stars are aligning for a long-waited increase in productivity. For the first time in nearly two decades, growth forecasts in advanced economies have been revised up this year at the same time that inflation forecasts have been revised down, it notes. That suggests an uptick in the efficiency of global output -- something that’s not being captured in the official data -- should boost growth in the medium-term.
Should confidence over the supply-side trajectory gain more traction, it will be easier for bulls to build the case that the growth outlook justifies low risk premiums in markets.
And then there’s the return of the Trump trade. While market participants aren’t holding their breath that tax legislation will see the light of day anytime soon, there’s cautious optimism. Even arch bears Morgan Stanley concede a repatriation tax would limit corporate bond supply and boost cash balances. Mikkelsen at Bank of America reckons high-grade credit spreads could hit a new post-crisis low over the next year, as the benefits elicited by tax reform offset a tighter U.S. monetary stance.