The US stock market is up about 9% since June 1 despite weakening fundamentals for US companies and weakening economies around the world, including in Europe. Morgan Stanley's Adam Parker thinks the reason for the rally is investors’ dream that macro policy in the US and Europe will prove to be more effective this time around than in the recent past.
Perhaps the incessant calls of market participants that things must be good given the performance of the market in the face of weakness are simply investors exhibiting the 5 Kubler-Ross stages of grief at a new reality that doesn't cognitively fit with their hopes and dreams...
Is Everyone A Contrarian Bull?
Underneath the market rally there has been some abnormal micro structure, including the fact that mega-caps have outperformed in an up tape, high beta has underperformed, and in the last month energy was the best-performing sector while materials was the worst, despite the 0.83 correlation between the two over the past 40 years.
Our stock selection strategy this year has been fairly defensive, focused on mega-caps, and has done pretty well so far despite the market’s rally. A few weeks ago we recommended trimming exposure to expensive defensives and to buy laggards or bombed out cyclicals, and we think there is more to go in that trade. After all, we gained a full year of returns from 10-year government bonds in just one day of equity market trading.
Sentiment is the key to the market outlook. I don’t really care that much about the prime brokerage data, the retail investor data, or the put/call ratio, as none of these is really effective at predicting the market’s subsequent return historically. Everyone talks about being pessimistic, but what I hear from my conversations with investors is generally optimism. Most people seem to think earnings are holding up pretty well, that the estimate reductions are a healthy reset, that macro policy will be more effective going forward. I have been told that if the market has held up this well despite all the bad news, just think how well it can do when the news improves. My response to all this optimism is to remind investors that analysts and investors tend to want to be optimistic and that the market runs on a buy-the-dream mentality. I am wary when people claim to be a contrarian bull today. They should not pretend they are alone on an island in their bullishness.
Perhaps BTFD has always meant Buy-The -F##king-Dream after all...
Source: Morgan Stanley