Over the last few weeks, there has been a rather rapid surge in risk appetite. FOMO has seriously kicked in and institutional investors, who have largely stayed out of the market in the current risk-on period are returning in droves. As such, the market has stormed upwards towards all time highs.
This is at least partially justified. There has been a material decrease in the US trade conflict with China as a "phase 1" deal is close to being rolled out. The tariffs which were going to be placed on EU automobiles have also been delayed. The world economy has seen some slightly more bullish PMI's in recent weeks.
However...
The risks remain material.
President Trump is, to say the least, erratic. The tariffs could be increased again rapidly if the deal he gets with China is viewed as insufficient. Similarly, given this is only a phase 1 deal, it is likely Trump will refuse to remove the other tariffs until further assurances from China can be given. It is unlikely that the purchasing of more Soybeans by China will be sufficient for Trump to remove all tariffs. There are larger issues like intellectual property rights still to be fought over.
The European economies remain highly weak, and the reluctance to engage in significant fiscal stimulus by Germany is concerning; particularly when the government can be paid to borrow money.
There are rumours that China is tired of the stimulus it is injecting into the economy, and any resolution of the trade war may lead to this stimulus being pulled back - essentially leaving the economy exactly where it is now.
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| Source: FT |
Finally, the US economy remains on a knife-edge. While it appears that the Fed's 3 and done manoeuvre may actually work, any increase in tensions or deterioration of the wider world economy would lead to a potential US recession. The probability of recession in the next 12 months has declined in recent weeks, but we are not out of the woods yet.
So why is the S&P500 at an all time high?
Largely, it is due to institutional investors re-entering the market after a year on the sidelines; fearing that their underperformance will cause distress for investors. After all, the S&P500 is up around 20% for the year. Now, this seems like an irrational reason to enter the market to me - the S&P500 is up 20% whereas I've been in cash and generated nothing, so let's buy at a now higher price and try and achieve gains.
The old Buffett adage: be fearful when others are greedy.
That's not to say that I have exited all of my long-term investments; they are primarily in value stocks, and a rotation into these industries is happening.
My final major reason for thinking the S&P500 will fall is because as the recession risk has declined, there has been an increase in yield on US Treasury bonds. Naturally, when the rest of the developed world is in essentially zero or negative yielding environments, this US real yield is highly attractive. So what do investors do? They pivot out of stocks, and rebalance towards bonds.
At the very least, on the shorter time frames, there has been an unprecedented amount of growth. The S&P500 has gone 25 days without posting two back to back losses. Remarkable. Are investors growing complacent? The wealthy currently hold 25% of their holdings in cash according to UBS, far higher than the 5% which they recommend. Can this rally really be sustained?
Ultimately, this market has rallied on hopes of a trade deal for the last year, and we must consider the possibility that this trade deal may never come to fruition.
Disclaimer: I've currently been purchasing significant quantities of Vix futures on the back of low volatility, and therefore I stand to benefit from any downside movement in the S&P500.
