(Bloomberg) -- What began as a tentative testing of the equity-market waters is giving evidence of morphing into something bigger.
While a long way from the fervid pitch of the post-pandemic years, there are signs speculative zest is spreading beyond just meme traders, who have pushed AMC Entertainment up 78% in two weeks and caused Bed Bath & Beyond to quintuple. Comparatively stodgy active fund managers just jacked up stock buying at one of the fastest rates in years, and measures of bullish options exposure are surging.
A model kept by Deutsche Bank AG measuring sentiment across a host of institutional traders -- while far from screamingly bullish -- shows enthusiasm stirring among the professional class. Volatility control funds, for instance, have increased equity exposure to 54% from 37% in mid-June. Broadly, the firm’s data show positioning is now half way to neutral after falling to the bottom of its typical range.
Manna for bulls, the trends also fit certain bearish theses, ones that view a revival in animal spirits as a precarious foundation for lasting gains in the face of an ultra-hawkish Federal Reserve. While it may be reasonable to deem the market’s first-half plunge as overdone, the thinking goes, a full-blown revival of last year’s passions would be harder to justify at this point in the tightening cycle.
“The U.S. equity market is now ‘priced for perfection’ in our view, with consensus expecting the Fed to pause in December, inflation to decelerate quickly, valuations to remain steady, a recession to be avoided, and EPS estimates to come down only modestly,” said Chris Senyek, chief investment strategist at Wolfe Research. “While the last two months have been very painful for us, we’re not backing away from our bearish intermediate-term outlook.”
Stocks rose for a third day, with the S&P 500 extending gains into a fifth straight week. Up about 17% from its 2022 low reached in June, the index now sits about 20 points below its 200-day average, currently near 4,326 -- a threshold that some see would flash a bullish signal on long-term momentum and prompt rules-based traders to step up purchases.
The latest rally, which began as a short squeeze, has picked up steam as data showed a robust labor market and cooler-than-expected inflation. According to a survey by the National Association of Active Investment Managers, equity exposure jumped to 72% from 20% over past eight weeks, the fastest increase since April 2021.
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In a separate poll by Bank of America Corp., fund managers are pulling back from their record pessimism about stocks, with money rotating to US equities and technology shares. While far from outright optimism, investors are “no longer apocalyptically bearish,” BofA strategists led by Michael Hartnett said.
In the options market, bullish contracts have been changed hands faster than bearish ones. The Cboe equity put-call ratio’s 10-year average fell to the lowest since April, a potential sign of growing interest in upside wagers.
“This move is driven largely by rising net call volumes in single stock options while those in index and ETPs saw only marginal increases this week,” Deutsche Bank strategists including Parag Thatte and Binky Chadha wrote in a note Friday. “Net call volume has rotated into cyclicals and financials.”
Also helping fuel the latest up leg are retail traders, who are embracing stocks again and seeking quick profits from options after dumping them during the worst of the rout.
Retail derring-do was the stuff of legend in the Covid panic. But playing chicken with a Fed bent on stanching inflation with jumbo rate hikes is something new. It’s accepted wisdom that day traders succeeded in the post-pandemic years due mainly to central bank largesse, paving the way for a multitude of valuation sins. Marshaling a speculative siege in the face of quickly tightening monetary policy requires a different brand of courage.
The resurgent optimism, along with Monday’s dismal data on New York state empire manufacturing and signs of a worsening slowdown in China, is why Greg Boutle urges investors to use options to hedge against a correction.
“We view signs of peaking inflation data as a necessary, but not sufficient catalyst for equities to settle into a lasting rally,” said Boutle, U.S. head of equity and derivative strategy at BNP Paribas. “The recent move is, in our view, starting to look over done. The growth outlook is going to remain challenging to navigate.”
©2022 Bloomberg L.P.
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