By Michael Msika, Bloomberg Markets live commentator and reporter
Investors’ fear of missing out is back, stoking a rally in equity markets that most strategists say has gone too far against a gloomy economic backdrop.
The Stoxx 600 has risen nearly 9% since hitting a 17-month low a month ago, though that doesn’t tell the full story of what has been a significant rebound for many cyclical sectors in a big turnaround from the first half. Tech is up 20%, automaker stocks have risen 16%, consumer and industrials each advanced about 15%.
According to Nomura cross-asset strategist Charlie McElligott, the rally has been “an angst-ridden pain trade” that’s leading to an “increasingly unstable FOMO-type behavior” and carries potential for further equities inflows.
Sentiment has changed quickly. Fears over hawkish central banks and sky-high inflation that had undermined markets for months have at least partly dissipated, while a relatively reassuring earnings season provided a further boost.
Yet strategists aren’t buying it, with those at Goldman Sachs, Bank of America, Barclays, HSBC, Berenberg and Generali Investments sticking to their view that there are downside risks ahead. Recent messages from Federal Reserve officials have been far from dovish, while Friday’s data showed a booming labor market, fueling concern that the Fed may raise rates sharply at its next meeting. In the UK, the Bank of England came out with one of its grimmest outlooks in history.
BofA strategists led by Sebastian Raedler have even turned negative again on European stocks, less than two months after upgrading their view to neutral, seeing 10% downside by the end of the year. They expect global macro momentum to continue weakening into the year-end and see European PMIs falling further, triggering underperformance for cyclicals.
On the credit side, things don’t look rosy. The iTraxx Europe, a gauge of credit default swaps, has receded from a peak in June, but is far from pricing quiet seas ahead, in contrast to equity volatility, which has fallen to January levels.
Technically, the rally has made the picture blurry, after several resistance levels were reached, including the 38% Fibonacci retracement. “From now on, what happens is very uncertain,” says DayByDay technical analyst Valerie Gastaldy. “In such instances, by experience, it is wise to take profits or to watch very short-term signals to adjust one’s exposure,” she says.
According to Barclays strategists led by Emmanuel Cau, the market feels “squeezy.” Further positive momentum may prompt more short covering and CTA buying, “as many bears are yet to join the party,” they say, while noting that an uncertain earnings outlook and a looming manufacturing slump should “keep the rally in check.”