Stealthily does it. A new year rally on Wall Street has propelled US stocks to their best January performance in 13 years. But can it last?
The strong run for financials, semiconductor stocks and small companies, all of which were battered in the turmoil of 2011, point to a bull run powered by hopes for economic recovery in America.
New York’s benchmark S&P 500 index, with a gain of 4.1 per cent for the year to date, was on course on Tuesday for its strongest January since 1999 and is at its highest level since July. Equity volatility as measured by the CBOE’s Vix, the so-called fear gauge, has dropped to its lowest level since last summer.
Semiconductor stocks were up 12 per cent and small-caps 7 per cent. The Nasdaq Composite was up 8 per cent, with Apple the star of the star of the earnings season.
By contrast, the three sectors in negative territory for the year are telecoms, utilities and consumer staples, defensive areas of the market peppered with high dividend-yielding companies that did well in 2011.
Notably, the Dow Jones Industrial Average trails other benchmarks, with many of its high dividend-paying blue-chips, including the likes of Verizon, Procter & Gamble, Coca-Cola and Chevron, experiencing a poor start to the year. Leading the Dow this year is Bank of America with a gain of 27 per cent.
Anthony Conroy, head of trading at BNY ConvergEx, says: “The big defensive stocks have made way for growth names and those that were hardest hit last year.”
One high-profile advocate of owning equities is Barton Biggs, founder of the Traxis Partners hedge fund. For the past six weeks he has maintained a net long position in equities at 65 per cent, but admits he faces a dilemma.
He says: “I’m terrified of missing a big rally, but I’m equally terrified of a possible apocalypse coming if the situation in Europe deteriorates and the euro [collapses].”
Bob Doll, BlackRock chief equity strategist, says: “At some point, it is inevitable that markets will take a break from the pace they have been on since the year began, but our outlook for stocks remains a positive one.”
It is not just the recent run of positive data on the US economy. Efforts by the European Central Bank to pump hundreds of billions of euros of emergency funding into the eurozone banking system have helped avert the threat of a credit crunch in Europe. The willingness of central banks to provide more support for the US, Chinese and European economies has, for now, reassured investors.
Liz Ann Sonders, chief investment strategist at Charles Schwab, says: “Markets are beginning to behave more normally. Last year, one needed to manage risk on and risk off almost every day. But this year may be better for stock pickers. That’s healthier.”
Yet, for bears and more cautious investors, the January lift is little more than an example of new year portfolio rotation, a bounce that will not last. The bulls, these investors argue, are misreading the data.
Last week’s move by the Federal Reserve to maintain near-zero interest rates until the end of 2014 and its hint at further “quantitative easing”, or QE3, to come, is as much a reminder of the dangers facing the economy as it is calculated to reassure. Moreover, the eurozone debt crisis is far from resolved.
In addition, the latest US growth data were boosted by strong inventory growth. That points to weaker activity in the coming months. At the same time, US fourth-quarter earnings have grown at their slowest pace since the upturn in profits began in late 2009.
More troubling have been low trading volumes and the relative absence among share buyers of institutional investors, pension and global fund managers – seen as a red flag for any rally. That absence has characterised the S&P’s rebound of 20 per cent from its cyclical low in early October.
Kenneth Polcari, managing director at Icap on the New York Stock Exchange trading floor, says: “Without volumes, rallies have no conviction. We are not seeing asset managers jumping on board this rally.”
Indeed, US equity mutual funds lost about $500m in January after $135bn in outflows during 2011, according to investment research company TrimTabs.
Mr Biggs at Traxis says: “People are still licking their wounds. There’s a tremendous buying power and liquidity on the sidelines, but people are waiting for less volatile markets.”
Mitch Petrick, a managing director and head for global market strategies at The Carlyle Group, says: “For a lot of people, the objective these days is capital preservation and not capital appreciation. Sitting on cash has become the most crowded trade.”
Even so, cash offers little or no real return. And the possibility that equities could continue to creep higher, buoyed by the likely injection of more cheap money from the Fed, will weigh on asset managers who have yet to return to risky assets.
James Dailey, chief investment officer at Team Financial Managers, says: “QE3 would accelerate the rotation we’re already witnessing from defensive stocks into materials and financials.”
Not for the first time since the financial crisis, then, investors are likely to take their cue from policymakers rather than earnings reports.
Additional reporting by Ajay Makan