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Traders All-In on S&P Bull Case Won't Listen to Warnings to Bail

Traders All-In on S&P Bull Case Won't Listen to Warnings to Bail

Tuesday, 19 June 2018 04:39 PM

Wondering how the U.S. stock market keeps skirting disaster? It’s not complicated. For all the drama at their doorstep, trader positioning remains overwhelmingly bullish.

It’s visible in manager surveys, which last week showed equity funds only a trifle less long than at the height of January’s euphoria. It’s in markets for call options, where individual investors are engaged in a buying binge of historic dimensions. It’s tech IPOs, stocks favored by short sellers and ones with shaky balance sheets, all of which recently surged.

For traders so inclined, each trauma is just another test, even as their frequency quickens. In Tuesday’s version, Donald Trump’s threat to slap on $200 billion more in goods from China sent the S&P 500 down as much as 1.1 percent, while the Dow Jones Industrial Average fell for a sixth day, the longest streak since March 2017.

“We’ve had more negative catalysts and more negative pull this year than we’ve had for a long time, but the positives continue to prevail in the investor’s mind,” Jeff Carbone, a managing partner at Cornerstone Wealth in North Carolina, said by phone. “They’re shrugging off the negativity and taking the positive to a greater extent that this is not the end.”

It’s not that people haven’t been warned. They have their memories of February and March, and strategists at banks from Morgan Stanley to Goldman Sachs have repeatedly urged investors to rein in optimism, citing everything from politics to peak earnings and monetary tightening. Earlier today, Citigroup flagged a potential bubble in growth stocks.

But the caveats have gone unheeded. In one example, smaller options investors, defined as those who typically trade 10 contracts or fewer in one transaction, last week purchased to open more than 4.5 million calls, an amount that before this January was unprecedented in records going back to 2000, data compiled by Sundial Capital Research Inc. showed.

While the rush to bet on higher share prices has helped the market stay buoyant this month amid an interest-rate increase from the Federal Reserve and growing trade tensions, it also sets bulls up for pain should things quickly reverse in coming months.

“This is fine for now, but we think by year end such a ‘risk on’ hierarchy will be misplaced given the more uncertain outlook posed by ‘peaky’ growth rates and ever tightening financial conditions,” Mike Wilson, chief U.S. equity strategist at Morgan Stanley wrote in a note to clients Monday. He urged investors to go defensive in anticipation of a rotation out of companies whose growth is tied to economic growth and upgraded utility stocks.

Wilson isn’t alone among analysts who see trouble brewing. The rally in growth stocks brought flashbacks of the internet bubble to Citigroup strategists led by Robert Buckland, even as valuation premiums are less than half of those almost two decades ago. A collapse would bode ill for a market whose gains have been increasingly anchored on tech giants such as Amazon and Facebook.

“Price action of the U.S. growth/value trade looks ominously similar to late 1999,” the strategists wrote. “Watch out for a growth bubble.”

Bulls have been unfazed, emboldened -- as always -- by a bedrock of earnings expectations that keeps getting stronger. Estimates compiled by Bloomberg show equity analysts see S&P 500 profit rising 24 percent in 2018 then 10 percent in each of the next two years.

Numbers like those make it easier to bid up companies that recently went public and those with weaker finances. An exchange-traded fund that tracks newly listed stocks, the Renaissance IPO ETF, last week posted its second-best gain this year while a Goldman Sachs basket of companies with flimsier finances outpaced their stronger counterparts.

To Matt Lloyd, chief investment strategist at Advisors Asset Management, all the anxiety over geopolitical turmoil will eventually fade.

“People, rightfully so, are just basically saying this could happen, that could happen, but those are 30 or 40 really bad decisions in a row that have to happen for those to come to fruition,” he said. “We always confuse hiccups for heart attacks when we’re adjusting to the news -- just what could happen versus what does happen usually.”

As bulls press ahead, bears have been retreating. A Goldman basket of 50 heavily shorted companies jumped more than 3 percent last week. In the options market, small traders have reduced their bearish wagers. As a result, more than two calls were bought at open for one put that changed hands, one of the highest ratios on record, Sundial data showed.

While options are often employed as a hedging tool by large speculators, small traders typically use them to make a direct bet on market directions, said Jason Goepfert, president of Sundial Capital. The latest buying in calls stood out in a market where broad equity trading remained anemic, triggering a spike in its ratio as a percentage of NYSE volume.

Coincidentally or not, such indications of retail euphoria flared up in January, just before the S&P 500’s first 10 percent correction in two years. It also accompanied the bull market peaks in 2000 and 2007.

“What’s most remarkable about the jump in call volume is that it comes during a time of overall suppressed volume,” Goepfert said. “That doesn’t exactly seem like a good sign.”

With the price of call options now trading above historic average, investors should sell them to reap extra returns in a market whose upside appears limited with valuations stretched, according to Rocky Fishman, an options strategist at Goldman Sachs. The firm predicted the S&P 500 will end next year at 3,000, or an 8 percent increase from the last close. That’d be below the 45th percentile in the index’s history over any 18-month period.

“The potential for upside surprises in U.S. equities is lower than the compensation received from elevated call prices,” he wrote in a note.

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Wondering how the U.S. stock market keeps skirting disaster? It's not complicated. For all the drama at their doorstep, trader positioning remains overwhelmingly bullish.It's visible in manager surveys, which last week showed equity funds only a trifle less long than at the...
stock, bulls, warnings, bail
Tuesday, 19 June 2018 04:39 PM
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