Some of the biggest money managers are vexed by the same paradox troubling everyone else: U.S. stocks are near an all-time high, but the world still seems to be falling apart.
Any number of looming threats could bring the historic rally in U.S. equities to a screeching halt, top hedge fund and mutual fund managers said. They include uncertainty over school re-openings, the November elections, tensions with China and the effect of monetary policy on inflation.
While the S&P 500 has surged more than 50% from its March low, that happened with unemployment in double digits and the federal government struggling to contain Covid-19. The equity rally also has lifted the index’s price-to-earnings ratio to 26, compared with an average of 18 over the past decade. All of this leaves some market insiders wary of calling this a recovery.
“There’s this massive disconnect between fundamentals and markets,” said Brian Payne, investment officer at the Teachers’ Retirement System of Illinois. “There’s just too much capital chasing investments, the Fed is flooding markets and that leverage isn’t going to the real economy. As we approach the election and concerns over a ‘blue sweep’ grow, that could be the inflection point where people’s bullish sentiment turns bearish.”
Chris Rokos’s multibillion-dollar hedge fund is modestly bullish in the short-term but sees volatility ahead, as the market underestimates the potential for bigger moves over the next couple of months.
To be sure, dour predictions have been piling up for months. On May 12, during a webcast held by the Economic Club of New York, Stan Druckenmiller said the risk-reward calculation for equities was the worst he’d seen in his career. The S&P 500 has climbed 18% since then, and Druckenmiller later said he was “far too cautious.”
And while many investors are vocal in their skepticism, their views don’t perfectly accord with the behavior of professional managers as a whole. The speed of the recovery in stocks has made the risk of missing out particularly pronounced this year, forcing fund managers out of cash and pushing measures of positioning toward historically bullish levels.
Shuttered Schools
Still, several prominent money managers are sounding the alarm. With children learning remotely, the impact on working parents could “be as disruptive to the labor market as a small to medium-size recession,” as they may be forced to reduce work hours or quit their jobs, U.K. hedge fund Brevan Howard Asset Management said in a note to clients this month.
“Investors need to add schools to their usual dashboard of economic indicators,” Brevan Howard said. “What’s happening with education has the potential to be as important as any other metric.”
Then there’s the race for a vaccine. It’s possible that a reliable one could take longer to develop than hoped, or that parts of the population will resist taking it, said Roger Aliaga-Diaz, chief economist for the Americas at Vanguard Group.