No edge, no hedge: why markets are stuck

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Team Trump is taking quite the victory lap as stock markets shrug off the seemingly trivial matters of war in Iran and a global energy crisis and crack through to fresh record highs.

Contracts based on the S&P 500 index, the go-to benchmark of US stocks often gratingly known as “spoos”, are “voting Maga”, according to David Zervos at Jefferies, who adds that doubters have a bad case of Trump Derangement Syndrome, or TDS.

“I realise that it must be super frustrating for all the hyper bearish TDS infused geopolitical gaslighters to see spoos back at record highs,” he crowed in a note this week. “And to be sure, I have no doubt that many of these folks are going to become even more unhinged when this skirmish soon passes and spoos rip further into the green!!”

It’s hard to argue with the facts here, even if you bristle at the sentiment and at being described as “unhinged”. The S&P 500, or spoos, if you insist, is up 4 per cent this year, having more than wiped out a drop in the early stages of the war in March that was never particularly heavy in the first place. Bond markets remain a little more nervy — they have not yet made up the gap back to where they were before the war started, still spooked by the potential for a reawakening of their arch-enemy, inflation.

But the bounce back from more gloomy days is undeniable. And yet the kind of ra-ra enthusiasm on display at Jefferies is rare. It’s worth asking why. Markets have mostly recovered, so why isn’t everyone joining that jump for joy? 

Instead, when you talk to people who analyse or invest in markets for a living, you hear a very consistent tale: we’re worn out, we’re sick of getting beaten up by headlines and by Donald Trump’s social media posts that flip markets higher and lower at random, we’re hopeful that the situation in the Strait of Hormuz is getting better rather than worse, but honestly we have no clue. Oh, and none of the usual shock absorbers are working. In short, investors have no edge, and no hedge. This puts a very firm lid on market enthusiasm.

In fact, a peek under the surface of how markets are performing gives a far less rosy picture than the admirably diehard optimists would like to believe.

For one thing, stocks are lacking a certain “oomph”. Often, investors can rely on prices pushing beyond the performance of the companies themselves. A higher price-to-earnings ratio is a good sign that investors are willing to pay up for the prospect of shinier corporate performances in future. Now, the mood is more humdrum. As Bank of America’s Savita Subramanian pointed out in a recent note, it’s earnings that are pulling stocks higher, not gung-ho hope and hype. The ratio of stock prices to earnings is down around 10 per cent since the end of last year. You know stock markets are feeling a bit poorly when they trade on fundamentals.

The rally is also narrow and, you guessed it, very reliant on the continued dominance of Big Tech. Only 44 per cent of stocks in the S&P 500 are trading at their highest point in four weeks, according to calculations from Sophie Huynh at BNP Paribas Asset Management. And it’s tech that is doing the heavy lifting, both in the US and elsewhere. 

Semiconductor stocks, in particular, are on scorching form. The Philadelphia Semiconductor index has not had a single down day in April and is up by a stonking 30 per cent in this month alone. Rightly or wrongly, we once again have a lot riding on this one, highly uncertain, theme.

Huynh says she remains bearish. The narrow reliance on tech and the failure of traditional hedges such as bonds and gold to counteract shocks leave markets still looking vulnerable to any further turbulence, she believes. “Portfolios are much more naked than before,” she said.

Weird market quirks also make her nervous. The Australian dollar, for example, has bounced back forcefully since the depths of market stress over the war, despite the country’s awkward dependencies on global energy flows. It all paints the picture of a market that is recklessly determined to ignore bad news.

Investors of all sizes appear very reluctant to give up on the formula that has worked so well now for decades: buy dips, and don’t sell your risky stuff in case it bounces back.

“We see this with our clients,” said Vincent Mortier, chief investment officer at Amundi in Paris. “Very few of them have been taking off risk. They don’t dare to, as they don’t want to be surprised. Because of the erratic environment, timing is impossible.”

This might leave asset markets in a spot where they are stuck. Neither extreme optimism nor extreme pessimism makes much sense, and neither is easy nor safe to express as investments. As Kit Juckes, an analyst at Société Générale puts it, markets are “paralysed by binary possibilities”. 

“We are still, unfortunately, watching paint dry,” he said. “Economic data have held up better than feared but that is largely a function of lags, rather than a reason to be optimistic.”

There’s a good chance that markets, like the ships in the Strait of Hormuz, are now stuck.

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