Dealers across the world’s financial markets are calling it September’s stealth rally. Even as gold, a haven for anxious investors, has hit record highs, the S&P 500 index has risen by more than 9 per cent this month and is on track for its third-best monthly performance in a decade.
The gains in global share prices, to five-month highs on Friday, have been all the more remarkable for coming against a backdrop of lingering fears about a double-dip recession and the health of the eurozone’s most indebted economies. US trading volume has been low and investors have continued to pull money out of stock market mutual funds.
Some economic data have been encouraging, such as Friday’s figures on durable goods orders. But strategists say one of the main reasons for equities’ resurgence has been a simple desire to take on more risk and seek out bigger returns.
With many fund managers having invested huge sums in fixed income and gold, and holding more cash in their portfolios, dividend yields are looking more attractive compared with the low interest rates on offer in Treasuries and money markets.
In spite of the mutual fund outflows, exchange-traded funds that track the S&P 500 have enjoyed solid inflows. US long equity ETFs added $14.6bn in September through last week, versus an outflow of more than $11bn in August, says TrimTabs.
Those inflows have underpinned the rally. And, as the index trackers have gained, so active fund managers have come under pressure to make decisions that will help them beat the performance of the world’s most benchmarked index by the end of the year.
One strategy, in an apparent break with the “risk-on, risk-off” style that has dominated the markets this year, has been to increase exposure to high-yielding stocks that are likely to pay a steady income.
“Investors are playing the yield game,” says Jack Ablin, chief investment officer at Harris Private Bank. “Dividend paying, defensive stocks are more attractive.”
Much of the S&P’s rebound from its late June and early July lows has been led by telecoms stocks, utilities and consumer staples, many of which sport chunky dividend yields that are attractive to investors with a cautious outlook.
Drill down into the index’s 10 main sectors and technology is up 12.4 per cent in September alone, consumer discretionary stocks are 11.4 per cent higher, industrials are up 11.4 per cent and materials 9.2 per cent firmer.
“There has been a broad-based rally this month,” says Jim Paulsen, chief investment strategist at Wells Capital Management. Indeed, the consumer staples sector is now close to its April high, within 5.4 per cent of its all time peak in 2007.
“Success seems to beget success in the current market, and a break out for a group that sports decent dividend yields and is broadly considered less exposed to economic forces is a pretty appealing combination,” says Nicholas Colas, chief market strategist at BNY ConvergEx.
Telecoms have risen 20.2 per cent from their low in late May, led by companies including Verizon and AT&T. Utilities have gained 12.7 per cent since the start of June, led by CMS Energy. Telecoms have benefited from inflows of ETF funds in September, adding 7 per cent to net assets, says TrimTabs.
Banks, though, are not recovering as quickly. While financials have risen 7 per cent in September, the sector is still down 15 per cent from its year high in April. The importance of financials as a group in the S&P means further gains for the overall market may depend to a large extent on banks finding a sounder footing.
“We doubt very much that the market can follow through without this group catching a head of steam,” says Mr Colas. But he adds that much of the bad news for financials is already public.
“Yes, we know they face regulatory risk, have opaque balance sheets and uncertain earnings power. The good news is that everyone knows that too.”
Others caution that it is precisely because of pending regulatory reform that financials could change fundamentally from a sector that has traditionally enjoyed a return on equity of 20 per cent-plus to one with a return on equity in its low teens.
The divergence between various industry sectors [see chart] is a sign of investors changing their approach. After the stock market gyrations earlier this year, when shares were bought and sold indiscriminately and companies from different sectors moved almost in lock-step, stock-picking may be making a tentative return.
Barry Knapp, equity portfolio strategist at Barclays, detects a more discerning focus that contrasts with the desperate mood in early July, at the market’s nadir, when investors dumped equities in heavy “risk off” trading.
“We’re entering more of a business cycle trade rather than a ‘risk on’ or ‘risk off’ trade,” he says.
September marks the end of the third quarter and investors will start to focus on the earnings season in October and future guidance from companies.
For the 2010 calendar year, John Butters, analyst at Thomson Reuters, says analysts expect dollar earnings of $83.43 for the S&P 500 as a whole and expect them to hit $95.37 in 2011, surpassing the record $88.18 for 2006.
From a valuation perspective, he says the forward price to earnings ratio for the next four quarters on the S&P is running at 13 times, below the historic range of 14 to 14.5 times.
For that ratio to return to its normal level, either stock prices will have to rise or reported earnings will have to fall.
Which of those happens is likely to determine whether the stealth rally really has legs.