Overheated markets are poised for a retreat amid concerns about inflation and flagging growth, according to signals from Wall Street.
Bank of America’s sell-side indicator – a contrarian measure of bullishness on stocks – was unchanged in August, holding at the closest to an overall “sell” indication since the financial crisis.
The gauge measures the average Wall Street recommendation for how much of investors’ portfolios should be held in stocks. It stood at 59.5pc in August for the second month running.
That left the measure – which BofA says is “far more predictive than many other vaunted market timing models” – the closest to the “sell threshold” since May 2007, after which the benchmark S&P 500 index fell 7pc on a total return basis.
Savita Subramanian, a strategist at the bank, said: “The continued pause in sentiment may reflect the mixed market data that includes a drop in consumer sentiment to the lowest levels since 2011, rising inflationary pressure posing risks for margins, and peak profit growth.”
She added that these were being counterbalanced by hopes for the US infrastructure bill, and continued faith in monetary support from the Federal Reserve.
Jill Carey Hall, also at BofA, noted there has been a “secular shift” away from equities over time, likely driven by “an ageing population pushing up fixed income allocations, and then a triple-whammy of asset hits – first the tech bubble, then the Global Financial Crisis and now Covid.”
The S&P 500 is on one of its longest-ever winning streaks, with 210 trading days since a 5pc pullback last October – the joint-eighth longest run without such a fall. During that period, its price has risen by about a third.
The index’s price rapidly recovered after slamming into a bear market at the onset of the pandemic, and is now more than double the lows reached in March 2020.
It has clocked up dozens of new record highs this year amid a blowout set of results for companies across America and Europe. Investors are hoping that the reopening of global economies will underpin continued earnings momentum over the coming months.
Nick Nelson, head of global and European equity strategy at UBS, said the first two quarters of 2021 had been some of the “best on record” for expectation-beating results.
The data we’ve got for August earnings upgrades to company profit expectations is the best since the data began in 1988 – that’s a 30-year-odd high,” he said. “That fundamental driver from profits is clearly underpinning most of the market moves.”
It has not been an entirely bump-free road, however. High inflation figures over the summer caused nerves, while Beijing’s crackdown on tech and education companies has damaged sentiment in some pockets of the market – with one index of Chinese companies listed in the US slipping by more than a fifth into a “bear market” in March.
In the weeks ahead, Germany’s federal elections and developing economic data showing the widespread impacts of global supply chain disruptions are likely to be a key focus.
Emmanuel Cau, head of equity strategy at Barclays, said markets had “been lacking clear leadership amid the mixed data and multitude of risks investors are grappling with as we exit summer”.
He added equities are no longer “priced for perfection”, with worries over future tapering of monetary support, action in China and further Covid setbacks now priced in.
Even as strategists worry about a possible bubble in the US, London’s top listed companies have still not recovered from a record-breaking plunge at the onset of the pandemic last year.
The FTSE 100 is still more than 200 points off pre-pandemic levels, underperforming wider indices and being outpaced by Britain’s mid-caps.
Mr Nelson said the index’s composition had proved “pretty unfavourable”, especially due to a lack of tech companies, but said recent takeover interest in the UK could boost valuations.