After a brutal stretch that has driven the S&P 500 into its worst start to the year in two decades, investors are predicting even worse declines in the stock market.
Recent negative wagers on U.S. equities by asset managers and hedge funds are at their highest since 2016 when worries about a global slowdown were at an all-time high. That’s what the futures contracts for key stock indices show, according to research by JPMorgan Chase & Co.
An assessment by the National Association of Active Investment Managers (NAAIMs), which primarily polled registered investment advisers, revealed that the average active investor has steadily pared her stock exposure this year and lost equity allocations to one of the lowest levels since the start of the pandemic.
Yet, several gauges of market mood are providing conflicting messages. Following a study conducted by the Federal Reserve Bank of New York, the majority of Americans (around two-thirds) believe that stock prices will either remain relatively stable or fall over the course of the coming year. Since the survey’s inception in 2013, this ratio is the highest it has been.
Many investors are understandably wary about placing their money into the stock market, as seen by the positioning and mood statistics. The bull run on major indices that started amid the height of the Covid-19 outbreak has ended this year with a thud.
What’s causing all the worry? A looming recession and persistently rising inflation are causing concern. Following the release of new economic statistics showing inflation at its highest level in 40 years, the S&P 500 dropped by 0.9% this week. The broad stock market index has already fallen by 19% for the year, its worst performance thus far in the year since 2002, according to data compiled by Dow Jones Market Data.
According to Parag Thatte, a strategist at Deutsche Bank, “everyone’s concerned on recession risk.”
The bond market’s most predictive recession indicator—the inverted yield curve—recently hit its widest level in two decades, signaling a warning message to the rest of the economy. In addition, many investors have upped wagers that the Federal Reserve would, at the next meeting increase rates by a full percentage point – this hasn’t occurred in decades.
Deutsche Bank’s estimates suggest that investors have reduced their stock holdings to record lows during the previous 12 years. This includes reduced holdings by systematic funds that trade in response to market volatility and other factors. In the meanwhile, large and small traders alike have been cutting their bullish wagers in the options market to the lowest level since April 2020.
Dunn Capital Management president Martin Bergin said his company was optimistic on stocks for much of the year but has begun trimming its bets and has adopted a little pessimistic stance in the futures market during the last month. Mr. Bergin is in charge of a trend-following approach, whereby investment choices are made systematically based on the performance of different assets and the linkages between different positions in his portfolio.
“We’ve now established that it’s preferable to be somewhat short rather than long,” Mr. Bergin added. We’ll start taking on additional long exposure if there’s a rebound.
This year’s investors have been hit with even more uncertainty due to: Some of the largest fluctuations in market history have been seen across a wide range of asset classes, from bonds to commodities and currencies. Because of this, some investors have been hesitant to place large wagers for fear of being caught off guard if the market reverses course suddenly. Some analysts, like Mr. Thatte, have suggested that investors may still benefit from reducing their stock exposure even after a particularly rough period for the market.
Roberto Croce, head of risk parity at Newton Investment Management Group, stated recently, “It’s as dangerous as it’s been in the previous 11 years that I’ve been doing this.” There may be more bad news for the market.
Mr. Croce is in charge of a risk-parity strategy that determines when and how much to purchase or sell stocks, bonds, and commodities depending on their perceived volatility and risk at any given time. During this year’s market volatility, he predicted that many such methods will reduce their stock market wagers.
Rather of purchasing bonds, which have declined as a group, many individual investors seem to be hoarding cash. According to a June study by the American Association of Individual Investors, this is the greatest percentage of cash reserves that individual investors have maintained since the beginning of the epidemic.
After seeing their investments plummet, some traders are hoping to cash in big. Since the start of 2022, trading volume has increased significantly in two of the major exchange-traded funds that give enhanced exposure to the stock market’s losses by placing wagers against the Nasdaq-100 and S&P 500 indexes. According to JPMorgan’s calculations, individual investors have continued purchasing this year, although at a slower rate.
When seen through a contrarian lens, the current level of caution in the stock market may provide hope for the remainder of the year. As reported by a JPMorgan team headed by Nikolaos Panigirtzoglou, heavy selling by institutional investors in the first half of 2022 may be followed by re-entry into markets in the second.
Classic investor behavior, according to Andrew Slimmon, managing director and senior portfolio manager of long equity strategies at Morgan Stanley Investment Management. “People are responding to what has already occurred by being cautious too late,” he said. Some equities that performed badly in the first half of the year may see better results in the second.
Mr. Slimmon reported reducing his exposure to defensive equities that had done well in the first half of the year in favor of purchasing shares in industries that had been struck particularly hard, such as the home building sector.
Read More: Investors’ Pessimism Is at an All-Time High