Why isn't the big money more fearful?
It's all good, right?
What's astonishing after the events of the past couple of months is not how fearful Wall Street is, but how complacent.
Major institutional investors remain heavily overinvested in stocks - even at almost unprecedented valuations - and underinvested in safer bonds, according to the latest closely watched survey from BofA Securities.
That bullish positioning leaves the market vulnerable to a much sharper pullback than we have seen so far, especially if any further bad news comes along to spark renewed fears.
A net 49% of fund managers are overinvested in the stock market, the survey shows. (A net 49% means the percentage who are overinvested exceeds the percentage who are underinvested by 49 percentage points.) This is down only slightly from last month's level and is high by historic standards.
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Meanwhile, the situation is almost exactly reversed regarding bonds, where a net 48% are underinvested. Fund managers also hold relatively low levels of cash and Treasury bills in their portfolios, although those levels have come off the lows seen a month ago. As cash is a superlow-risk asset in the very short term, the amounts that fund managers hold in their portfolios is often a good indicator of their optimism or pessimism.
The overall picture is one of serious cognitive dissonance.
Money managers are extremely worried about bonds, with some reason. Persistent inflation is bad for fixed-income investments. More ominously, thanks to the scale of U.S. budget deficits and the national debt, markets are starting to question the underlying solidity of Treasury bonds themselves.
Yet any reasons to be worried about bonds are also reasons to be worried about stocks. If someone can think of a way that a U.S. debt or inflation crisis would somehow leave the stock market unaffected, it would be very interesting to hear it. In the European sovereign-debt crises of 2011-12, the stock markets of the affected countries - Portugal, Ireland, Italy, Spain and Greece - fell by 50%.
Stocks offer very little margin of safety for investors, if any. At current stock prices, the U.S. stock market is valued at about 230% of annual gross domestic product - a level far beyond those recorded in the past, even during acknowledged bubbles such as 1999-2000 and 2006-07.
This is an indicator previously cited by Warren Buffett as one guide to the attractiveness of stocks.
There are always reasons to be worried about the economy and the financial outlook, which is one reason economics is known as "the dismal science." Perhaps the reasons today are no worse than those in the past. They include oil prices (CL00) (BRN00) at more than $100 a barrel, a war with no plan in the Persian Gulf, 7% mortgage rates, rising interest rates, real fears around a U.S. debt crisis, and worries about an AI investment bubble (coupled with fears of an AI apocalypse for the human race).
But the fears aren't being matched - yet - by fund managers' asset allocations. They are still partying like it's 1999.
Meanwhile, for those looking to fish where the big boats aren't, the survey - as always - is a great guide to the assets most out of fashion among big-money investors. Currently, that includes bonds and cash, real-estate investment trusts and consumer-discretionary stocks XX:SP500.25.
But the big standout at the moment is the field of consumer-staple stocks XX:SP500.30 - those companies that make money come rain or shine, such as Walmart (WMT), Costco (COST), Coca-Cola (KO), PepsiCo $(PEP)$ and Procter & Gamble (PG). The Vanguard Consumer Staples ETF VDC and the State Street Consumer Staples Select Sector SPDR ETF XLP have fallen just over 5% in three weeks. At about 19 times forecast earnings, the sector is hardly cheap by any historic measure - but it may be relatively cheap compared to the alternatives.
-Brett Arends