Dimming Risk Appetites Welcome Development for US Equity Bulls

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(Bloomberg) — Beneath the surface of a stock market sitting at record highs, signs of trepidation are building.

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Worries about resilient inflation, bond market volatility and the war in Iran are weighing on investors, pushing gauges of positioning to levels that suggest some of them don’t own enough equities, according to an analysis by Jefferies LLC. 

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Rising worries are also evident among hedge funds, where short positions in products that protect against broader declines in the US stock market are hovering at a 10-year high, according to traders at Goldman Sachs Group Inc.  

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The newfound uncertainty is music to equity bulls’ ears as it puts a brake on overheating in a stock market that has posted a record every other day since mid-April. Cash sitting on the sidelines could be put to use, should the biggest risks around the artificial intelligence trade and the situation in the Middle East fail to materialize. 

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“Strong Nvidia results and more positive headlines on potential US-Iran peace deal can contribute to a squeeze higher in equities as hedge funds could be forced to cover their short positions,” said Frank Monkam, head cross asset macro strategy and trading at Buffalo Bayou Commodities.

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The S&P 500 Index is up 17% since hitting a near-term trough in late March amid hopes for a peace deal in Iran and optimism over corporate earnings at home that have exceeded expectations. 

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To strategists at Jefferies, sentiment around US stocks remains unusually subdued considering the stock market’s scorching rally. They cite two gauges: One is a survey from the American Association of Individual Investors, where bears are back to outnumbering bulls. The latest reading is sitting at -12, far from the range of positive 20 to 30 that’s consistent with excessive enthusiasm, the bank’s strategists  including Andrew Greenebaum say.  

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The divergence between the stock market performance and investor sentiment is rare. When the S&P 500 sat this close to its 52-week high in the past, the bull-bear spread has averaged positive 14.6, data compiled by Bespoke Investment Group show. 

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The other gauge is a rough measure of stock exposure among mutual funds tracked by the National Association of Active Investment Managers. It slipped by almost 20 points to 77.3 in the latest reading, suggesting managers took some profits. 

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Hedge fund managers in Bank of America’s latest survey showed a similar urge to unwind equity exposure. Last week, the group pulled the largest amount of money out of US stocks in dollar value since at least 2008, when the bank started tracking the data. 

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The growing uncertainty lands on the market where fundamentals remain solid. With most of first-quarter earnings in the rear-view mirror, profits in the S&P 500 have grown around 29% from the same time a year ago, the most since 2021, data compiled by Bloomberg Intelligence show. About 83% of companies in the gauge posted profits that exceeded estimates, the most in 19 quarters, the data show.