Date: 26-08-2016
Source: The Wall Street Journal
Investors’ complacency after piling into similar positions could be setting up markets for a burst of volatility
Investors are worried that some of this year’s most popular trades are vulnerable to a reversal.
Government bonds, dividend-paying stocks and emerging-market securities have been bid up in the global search for yield. In an unusually quiet market, any shift in sentiment could send investors who have piled into similar positions all heading to the exits at the same time. One test could come as soon as Friday, with Federal Reserve Chairwoman Janet Yellen scheduled to speak at the central bank’s annual conference in Jackson Hole, Wyo.
Investors’ complacency is setting up markets for a burst of volatility, many traders and analysts say. U.S. stock-trading volumes are near their lowest levels of the year, and the CBOE Volatility Index, which rises when investors are fearful of stock-market declines and are buying options to protect themselves, has fallen below 14. Its 10-year average is 21. “Things have gotten crowded, and we’re ripe for a bit of give-back if investors get worried,” said Sean Lynch, co-head of global equity strategy for the Wells Fargo Investment Institute.
Two of the most crowded sectors right now are consumer staples and utilities, according to analysis by Vadim Zlotnikov, a co-head of multi-asset solutions and chief market strategist at AllianceBernstein LP. Such stocks have been popular this year because their regular dividend payouts make them attractive as income-bearing substitutes for bonds. Utilities are the second-best-performing sector of the S&P 500 so far in 2016, rising 15%.
Mr. Zlotnikov’s analysis ranks North American-traded utilities stocks in the 94th percentile in terms of how “crowded” they are as of mid-August compared with the past 18 years. Consumer-staples companies are in the 99th percentile. Energy stocks, which are up nearly as much as utilities so far this year in the S&P 500, are in the 9th percentile.
Overwhelmingly popular, or “crowded,” trades in recent years have tended to provide some outperformance on the way up, but lose all those gains and more in the subsequent drawdowns, according to the analysis.
Globally, stocks that were most crowded had an annualized return of three percentage points more than their benchmark between June 2003 and June 2008, Mr. Zlotnikov’s analysis shows. Those most-crowded trades between July 2008 and August 2016 returned one percentage point below their benchmark.
Mr. Zlotnikov identifies crowded trades by looking at top positions of active managers globally, what they have been adding to in the past several quarters, and which positions have a very high proportion of “buy” ratings from bank analysts who cover the companies. He said he also takes into account how well an investment has done compared with the rest of the market, and how well it is expected to do going forward.
Ultralow rates around the world have pushed investors into a range of higher-yielding alternatives.
Emerging-market funds have seen net inflows of $13.2 billion since late July—more than mature-market funds in terms of assets under management, according to the Institute of International Finance. The share of emerging-market assets in portfolios of global mutual-fund and exchange-traded-fund investors reached 11.7% by mid-August, the highest level in a year, according to IIF.
“What we’re seeing is yield tourism,” said Alex Dryden, global market strategist at J.P. Morgan Asset Management. “That’s all well and good, but people seem to have forgotten that higher yields come with higher risks.”
Shifting expectations have upended popular bets in the past.
The Fed’s announcement that it was considering slowing the pace of its bond purchases in 2013 sent Treasury yields sharply higher. That was particularly damaging for emerging-market debt, which had benefited from years of easy-money policies that had encouraged investors to pour money into these higher-yielding securities.
More recently, a swift rise in German government-bond yields last spring pulled other developed-market bond yields with it as investors reassessed the inflation outlook and judged that concerns over a scarcity of German bonds for the European Central Bank to buy were overdone. The 10-year bund yield went from just above zero to just below 1% in under two months.
“A ‘bond shock’ remains the key autumn risk for markets,” strategists at Bank of America Merrill Lynch wrote in a report dated Wednesday. The strategists point to evidence of economic strength in the U.S., with wage inflation at its highest level since early 2010. Still, the biggest catalyst for a bond selloff would be stronger economic data out of Europe and Japan, they said.
Colin Graham, head of active asset allocation at BNP Paribas Investment Partners, said only a position in inflation swaps—a type of derivative used to wager on future price rises in the economy—notched a positive return out of his entire multiasset portfolio following the “bund tantrum.”
“It has been indelibly inked on my brain. That is my worst nightmare,” Mr. Graham said.
