By Akane Otani
Hopes for a trade deal have sparked renewed optimism among stock
investors. It is a cautious optimism, though.
The S&P 500 is less than 2% away from its all-time high
after rallying Friday on reports that the U.S. and China reached
what President Trump described as a "phase one" agreement. With its
18% rise in 2019, the index is outperforming benchmarks from Europe
to Brazil to Japan.
But much of the gains over the past month have been driven by
parts of the market that investors tend to gravitate toward when
they are looking for safety, as well as an attractive yield.
The S&P 500's real-estate and utilities sectors, often
considered bond-like because of their relatively hefty dividend
payouts, have climbed 1.3% and 1.9% respectively over the past
month while the broad index has fallen 1%. That makes them by far
the best-performing groups in the broad index over that time,
followed by technology shares. Exchange-traded funds that aim to
minimize investors' exposure to market swings have also gained
popularity, with flows into low-volatility equity ETFs surpassing
$20 billion this year -- nearly 20 times that of growth stocks,
according to Strategas.
In the meantime, money managers have moved away from shares of
companies that tend to get hit hardest when the economy weakens.
Steven Violin, a portfolio manager at F.L.Putnam Investment
Management, said he has recently trimmed his investments in
multinational industrial stocks. He has also generally favored
large U.S. companies over smaller ones -- the latter being more
sensitive to a potential slowdown in U.S. growth.
The shifts in the stock market suggest that, even as the broader
index approaches new highs, many investors are wary the gains could
be fleeting. Among the reasons that stocks could fall: Global
economic growth could start to slip more rapidly, central banks
could disappoint investors by easing monetary policy less than
expected, or the U.S. economy could show signs of weakening beyond
the manufacturing sector.
Investors will get a look in the coming days at earnings reports
from big banks, as well as Netflix Inc., International Business
Machines Corp. and Johnson & Johnson. They will also get a
fresh read on retail sales, industrial production and housing
starts. While data this year have generally shown the U.S. consumer
on strong footing, measures of factory activity and confidence
among business executives have declined, a trend increasingly
weighing on many money managers' optimism.
"In a world where the U.S. can skate by without a recession,
yields might not move that far lower," said Nicholas Colas, founder
of DataTrek Research. The fact that bonds and their stock proxies
have held onto large gains for the year, though, suggests there is
still rampant skepticism about the growth outlook, he said.
Some money managers have already begun to shift money out of
riskier investments.
Morgan Stanley Wealth Management has positioned itself to carry
a lower-than-average share of U.S. stocks in its portfolios,
reasoning that both economic growth and earnings growth have
"slowed materially this year" and will likely weigh on the market
in the coming months.
"Our contention is that there's going to be a disconnect between
expectations and reality," said Lisa Shalett, chief investment
officer at the firm. She added she believes the likelihood of a
Goldilocks scenario -- one in which the economy grows just fast
enough to support riskier assets, but not fast enough to spur a
tightening of monetary policy -- has diminished in recent
months.
Even those who contend that a recession isn't imminent say it is
hard for them to imagine how much more the broad market can climb
without a firm trade agreement between the U.S. and China, or a
material pickup in growth. Stocks surged Friday on reports of a
partial trade deal, but then ended well off of their session highs
as subsequent reports showed the two countries still hadn't agreed
on key issues including how China would enforce intellectual
property rules and what the U.S. would do with existing tariffs on
nearly $360 billion of Chinese imports.
For risky assets to sustainably rally from here, investors will
have to see that a trade deal is having tangible effects on the
economy, as well as lifting corporate confidence, said Katie Nixon,
chief investment officer of Northern Trust Wealth Management.
Part of the reason that stocks have been able to churn out gains
at the pace they have this year is because global bond yields have
slumped as much as they have, said DataTrek's Mr. Colas. That has
created a scarcity of opportunities for investors to find yield --
and heightened the relative attractiveness of U.S. stocks, even as
earnings growth has dropped off.
S&P 500 companies are currently projected to post a drop in
earnings for the third straight quarter, according to FactSet. That
would mark the longest such streak since a period of softening
global growth from late 2015 to early 2016.
Ultimately, "you'll need the trade issue to get resolved," said
Mr. Colas, who added that his worry is that prolonged uncertainty
over tariffs will deter companies from hiring and consumers from
spending.
The one silver lining? U.S. stocks are in the midst of what has
historically been one of their strongest months of the year. Over
the past two decades, the S&P 500 has posted its second-biggest
gains of the year in October, according to the Stock Trader's
Almanac.
And while memories of last year's fall and winter rout have some
on edge, others believe there are reasons to believe this year
might be different. Unlike in 2018, central banks are firmly in the
midst of lowering interest rates and in some cases deploying
further stimulus to try to stave off an economic downturn.
"I'd have to ask, what are the odds of two bad fourth quarters
in a row, " said Todd Sohn, director of technical strategy at
Strategas.
Investors' positioning in more defensive areas of the stock
market may already be approaching extreme levels, Mr. Sohn said,
which could result in a swift reversal back into more cyclical
sectors should there be any breakthroughs in economic data or trade
negotiations.
"I'd guess that's when you see the market finally punch through
to its next highs in a sustainable fashion," he said.
----Amrith Ramkumar contributed to this article.
Write to Akane Otani at akane.otani@wsj.com
(END) Dow Jones Newswires
October 13, 2019 05:44 ET (09:44 GMT)
Copyright (c) 2019 Dow Jones & Company, Inc.