Prominent money managers have stopped chasing the latest stock rally, according to recent reports. The rationale behind this move is the belief that expectations for easier Federal Reserve monetary policy are overblown with inflation still running high. The thinking among these money managers is that should any rate cuts come, they would be intended to halt an economic downturn that would also bode poorly for equity returns. Barclays Wealth Management recently closed out an overweight position on developed market stocks two weeks after initiating it, while Legal & General, which manages $1.4 trillion, has cut its equity exposure down to the biggest underweight since the pandemic, concluding that the hit from aggressive tightening will continue to play out on the US economy for months to come.
After the bank turmoil this month, asset managers shifted their stock exposure from close to neutral to a level halfway towards historically low underweight measures, according to Deutsche Bank AG. “Market-implied estimates may be exaggerating rate-cut potential before year-end,” said William Hobbs, chief investment officer at Barclays Wealth Management, who favors defensive positioning.
Despite this caution, the tech-heavy Nasdaq 100 saw a 20% advance during the first quarter of 2023, its best quarterly gain since 2020. Speculative fervor has also boosted the price of Bitcoin by more than 70%. Markets determined to leave worries about banking sector contagion behind have put falling bond yields and rosy reads of a looser Fed balance sheet in their sights, a view that directly contrasts with the latest messaging from Federal Reserve officials. Boston Fed President Susan Collins Friday said that more needs to be done to bring inflation down, while Fed Chair Jerome Powell has insisted that officials don’t anticipate cutting rates any time soon.
Markets have priced in a sanguine scenario where cooling inflation triggers 60 basis points of rate cuts by the end of the year. However, the argument that easing inflation will allow the Fed to wind down its rate-hiking cycle was helped by a report last month showing US inflation rose by less than expected and consumer spending stabilized. Still, such priced-for-perfection sentiment can quickly turn around, as Nouriel Roubini, chairman of Roubini Macro Associates, recently noted at a gathering of economists by Lake Como: “We cannot achieve price stability, maintain economic growth, have financial stability at the same time.”
Fund flows underscore jitters about the risk rally. Investors flocked to cash with $60 billion entering money market funds while they withdrew $5.2 billion from global equity funds in the week through Wednesday, according to Bank of America, citing EPFR Global data.
For Legal & General, the turning point came when the wobbly balance sheets of US regional lenders like SVB Financial Group were exposed, and a liquidity crisis swamped Credit Suisse Group AG. The full impact of the Fed’s aggressive rate increases has yet to be fully absorbed by the American economy, warned John Roe, the head of multi-asset funds at Legal & General. He’s both cut his exposure to equities and added recession hedges in the form of long-duration government bonds. “There’s never only one cockroach,” said Roe. “The SVB case isn’t isolated. It’s about the growing risk that the hikes so far in the end restrict lending — the standard lagged effect of monetary tightening.”
While Wall Street strategists haven’t changed their year-end targets, both systematic and discretionary managers have decreased exposure rapidly since March 8. The equity exposure of systematic investors fell to the lowest since 2021 as trend-following quants were caught in wild swings of the early days of the banking turmoil. Discretionary funds have now cut back exposure to underweight after hovering close to neutral levels at the beginning of March, according to Deutsche Bank. Meanwhile, Fed officials