Both retail and professional investors have become more bullish in recent weeks. Allocations to stocks are rising; allocations to bonds are declining. You can’t blame them for getting excited. There’s good reason for exuberance: The soft landing remains the dominant investing paradigm; The Fed is cutting rates going into a soft landing (very unusual); Corporate America has become the largest buyer of U.S. stocks; Stocks are entering the seasonally strongest period of the year; and Hopes for political gridlock and/or a Trump win are boosting some sectors. Soft landing remains dominant paradigm The October Bank of America Global Fund Manager Survey, a monthly survey of global fund managers, was about as optimistic as you could get. Fully 90% expect a “soft landing,” or “no landing” at all (i.e. the economy remains strong). BofA: fund managers who expect: Soft landing: 76% No landing: 14% Hard landing: 8% Source: BofA Indeed, worries about a U.S. recession was the predominant red flag throughout the summer, but those concerns are fading, replaced by fears surrounding geopolitical conflicts. Biggest tail risk for investors Geopolitical conflict 33% Global inflation accelerates 26% U.S. recession 19% (down from 40%) Source: BofA Fed is cutting rates going into a soft landing The Fed usually cuts rates when the economy begins to significantly weaken. That’s not the case here: the Fed is cutting rates going into, at worst, a soft landing, which is very unusual. Alicia Levine, BNY Wealth head of investment strategy, is in the “no landing” camp, that is, she continues to believe the economy is growing at an above-trend rate (she noted two quarters in a row of roughly 3% GDP growth) and that this is bullish for equities. “When the Fed cuts into a soft landing or no landing, which is what we think is happening, if you look back at six previous examples of this, the S & P 500 is up 16% in the 12 months and 44% in the 24 months after the Fed starts the cutting cycle,” she said on Squawk Box Tuesday. Buybacks are huge Corporate buybacks are a major factor in the rally this year. Goldman Sachs estimates U.S. corporations themselves are the largest buyer of the U.S. equities market in 2024. Through October 4, Goldman estimates $988 billion in announced buybacks were made so far in 2024, up 21% from 2023, likely a record year. While announcements get a lot of attention, it is the execution of the buybacks that actually result in share repurchases. Goldman estimated that 21.1% of all buyback executions occur in November and December, the strongest two-month period of the year for buybacks. Stocks are entering the strongest season of the year The seasonal weakness typically exhibited in September and October has not happened this year. The S & P 500 was up 2.0% in September and is higher by 0.9% so far in October. Historically, the S & P tends to rise beginning in the last week of October and through November and December. In election years, the seasonal November rise tends to be delayed until after the election, Goldman has noted. The election: volatility declines, stocks tend to rise Many believe that part of the credit for the market’s strength is due to Trump’s recent improvement in the polls and the possibility of a divided Congress. That certainly may be a factor, but the key point is the fact of the election itself: the historical evidence is that volatility tends to decline after an election, and stocks generally tend to do better. Goldman Sachs noted that, since 1928, the median S & P 500 return from October 15 to December 31 has been 5.17%. But the median S & P 500 return from October 15 to December 31 in election years is 7.04%, a significantly better performance. Things to worry about: sentiment With all that, who could blame investors for getting excited? Still, there’s excited, and there’s frothy, and we are starting to enter frothy territory. The American Association of Individual Investors sentiment survey shows bullishness near the highest levels all year. AAII Bullish/Bearish survey (week ending 10/9) Bullish 49.0% Neutral 30.4% Bearish 20.6% Source: AAII Bullish sentiment at 49% is very high: the historic average is 37.5%. Same with professional investors. The October BofA Global Fund Manager Survey saw the biggest jump in investor optimism since June of 2020. BofA noted that fund managers were rotating into cyclical sectors (industrials, consumer discretionary, and energy) and cutting exposure to defensive sectors (consumer staples and utilities, though exposure to utilities is still high). Those professional investors also were holding very low cash levels, going from 4.2% (low) to 3.9% (very low), or the lowest since February 2021. BofA considers levels below 4% to be a “sell signal.” Other risks: momentum and election The risks: several sectors, such as industrials and financials, along with roughly 15% of the S & P 500 are now overbought (showing Relative Strength Indicator readings above 70). What that means: when stocks and sectors are above those levels it is historically difficult for them to keep advancing in the immediate future. A bigger risk may be the election itself. The Cboe Volatility Index (VIX) remains at 20, slightly elevated compared to where it has traded most of this year (roughly 12-17), but inline with its historic average of 20. The market seems to be assuming a clear winner will be forthcoming in the election and stocks will rise immediately after, but that outcome is far from certain. If the election is gridlocked after Nov. 5, with no clear outcome, that would increase uncertainty and may delay any rally.
